What Is Realized Yield?
Let me explain realized yield directly to you: it's the actual return you earn during the time you hold an investment. This includes things like dividends, interest payments, and other cash distributions you receive. You can apply this term to a bond you sell before it matures or to any security that pays dividends. For bonds, realized yield factors in the coupon payments you get while holding it, plus or minus any change in the original investment's value, all calculated annually.
Key Takeaways
- Realized yield is the actual return earned during the holding period for an investment, and it may include dividends, interest payments, and other cash distributions.
- The realized yield on investments with maturity dates is likely to differ from the stated yield to maturity under most circumstances.
- In the bond market, it is common to use the terms 'realized yield' and 'realized return' interchangeably.
- The term 'realized yield' is applied to bonds, CDs, and fixed-income funds, but 'realized return' is generally the preferred term for stocks.
Understanding Realized Yield
You should know that the realized yield on investments with maturity dates usually differs from the stated yield to maturity (YTM) in most cases. There's one exception: when you buy and sell a bond at face value, which is also its redemption price at maturity. For instance, if you buy a bond with a 5% coupon at face value and sell it at face value, your realized yield is 5% for that period. The same bond held to maturity also gives a YTM of 5%. In every other situation, you calculate realized yields based on payments received and the change in principal relative to what you invested.
What you're really getting as a bond market participant is the realized yield, not necessarily the stated YTM. Consider two bonds with identical credit quality: a one-year bond with a 3% coupon and $100 principal selling at $102 is about equivalent to a one-year bond with a 1% coupon at face value. Both have a YTM around 1%. But if market interest rates drop by half a percentage point a month later, causing one-year bond prices to rise 0.5%, and you sell after that month without any coupon payments, your realized yield jumps to a little over 6% annually.
Realized yield is particularly useful for evaluating high-yield bonds, as it helps you account for the reality that some of these bonds will default.
Important Note on High-Yield Bonds
Keep this in mind: the realized yield of a high-yield bond fund is likely lower than its yield to maturity because of defaults.
An Example in the High-Yield Bond Market
To illustrate how realized yield works in the high-yield bond market, suppose interest rates and default risk remain steady for a year. One-year Treasuries offer a YTM of 0.5%. Meanwhile, a high-yield bond fund has a YTM of 5%, but 3% of its bonds default that year. As a result, the fund's realized yield drops to just 2% due to those defaults, compared to the 5% YTM. In contrast, the Treasuries deliver a realized yield of 0.5%, matching their YTM exactly.
Realized Yield vs. Realized Return
Realized yield, much like realized return, is simply the money you actually made as an investor. In the bond market, people often use 'realized yield' and 'realized return' interchangeably. However, when it comes to the stock market, 'realized return' is the term you typically hear instead of 'realized yield,' except for high dividend yield stocks.
Types of Realized Yields
Let's break down the types starting with bonds. Realized yield is your total return when you sell a bond before maturity. Take a bond maturing in three years with a 3% coupon bought at $1,000 face value, which has a YTM of 3%. If you sell it after one year at $960, that's a 4% principal loss, and with the 3% coupon, your realized yield is a negative 1%. But if you sell at $1,020 for a 2% gain, the 3% coupon pushes the realized yield to 5%.
Now, consider early CD withdrawal. If you cash out a certificate of deposit before maturity, you often face a penalty. For a two-year CD, it's typically six months of interest. Say you cash out a two-year CD paying 1% after one year, accruing $1,000 in interest, but the penalty is $500. After that, you net $500 over the year, giving a realized yield of 0.5%.
Finally, fixed-income funds follow the same calculation, even without maturity dates, like ETFs. If you hold an ETF paying 4% interest for two years and sell for a 2% gain, that's 4% per year in interest plus 1% per year from the principal increase, totaling a 5% annual realized yield.
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