What is bond yield?
First off, if you aren't sure what a bond is, you can read our introductory post on bonds.
But what is bond yield? In simple terms, bond yield is the interest payment you get for buying a bond. There are quite a few more pieces than that while we'll look at below, but the easy answer is that it's what YOU get for investing in a company. Think of it as a "guaranteed" dividend.
Consider this scenario:
Friend: "Hey, can I borrow some money?"
You: "Sure, no problem. How much did you need to borrow?"
Friend: "Maybe $10,000?"
You: "Ok... what kind of interest did you have in mind?"
Friend: "Don't worry about it."
Anyone want to make that deal? I don't.
You have to understand what you're getting paid for your risk. It's the very foundation of investing.
Why is yield important?
Bonds are an important part of any portfolio, especially in late-stage retirement portfolios, (although our strategies rely heavily on bonds to generate income for equity investment, even for early-stage investors).
Bond income (read: yield) is calculated as an annual percentage relative to your investment amount.
For example, say you invest $100 in a bond and it pays you $6.00 per year. That would be a 6% yield. If it's a 10-year bond, you would get $60.00 back for a total of 60% at the end of the 10 years.
Of course, this example ignores compound interest.
Estimating your bond income is just as important to budgeting as knowing your salary!
How does yield fit into a portfolio?
Yield is a very important part of late-stage investing and retirement finances.
Because yield is an income stream, it functions as a replacement to a retiree's salary. It's entirely possible to replicate pre-retirement salary with yield, depending on the size of the nest egg. See our calculator below.
Some people get yield from bonds, some from dividend-paying stocks (remember, those stocks can cut their dividends if needed), preferred shares, options, or a variety of other sources.
Bonds are the simplest to understand. Lend money, get paid.
What is a good yield?
Since typically speaking, risk is tied to reward (not always though, there are ways to tweak the formula), a "good yield" is hard to define.
Good yield should be a fair return on your risk.
If you're taking large risks, your yield should be very high to compensate for the excess risk. On the other hand, if you're taking safer bets, your yield should be lower to compensate for the lower risk on the debt.
A "good" yield is one that accomplishes your own goals. If you need $100,000 per year to retire comfortably, a good yield gets your $100,000 per year with the lowest risk possible.
If you could net $200,000 per year, but you only need $100,000 per year, a good yield would be something that gets you what you need (including emergency funds).
Credit Ratings in a Nutshell
For the most part, bond yields are a direct result of credit ratings. What's a credit rating you ask? Well, it's a grade on a company's risk of default. Think of it as taking a company's health report. 98.6 fahrenheit, a perfect BMI, perfect blood pressure, low cholesterol, etc. would be an AAA rated bond.
104 degree fever and pnemonia would be a C-rated bond. There's a fair shot it's going belly up.
Each provides rating on a slightly different system, but similar. If you're shopping for bonds, it's important to review ratings before pulling any triggers.