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Average annual yield is a term used to express the average increase in value that a multi-year investment has generated over the course of a single year, and is usually a percentage of the total investment's value. It is often used for investments like certificates of deposit (CDs) that banks issue, where the interest rate paid on the deposit can be variable. Variable interest rates can result in a high yield in some years and a lower one in others, and, since financial instruments that have variable interest rates have to be marketed in a way that is compelling to consumers, an average annual yield is included in the marketing to encourage investors to buy the product.
Other types of investments besides CDs that an average annual yield can be determined from including savings accounts in banks that pay interest, mutual funds and index funds based on stock market trends, yield bonds, and insurance based annuities. The yield is based on a total initial investment that has not seen any withdrawals during the period from which the percentage of growth is calculated. It is also a frequent method for calculating growth rates for an entire portfolio of investments, which can include stocks, bonds, accrual of value in real estate, and more. The entire investment package's change in market value is averaged over the course of a year to determine net losses or gains in terms of a percentage value of the whole.
Other terms for the average annual yield computation in investing include rate of return (ROR), annual total return (ATR), return on investment (ROI), and others. Annual percentage rate calculations of this nature are often used as benchmarks to determine if an investment is outperforming or under-performing in the market. Common financial investments, such as CDs and mutual funds, are also sold to the public by their promise of certain guaranteed or predicted rates.
The calculation for what the return rate is can be fairly simple. An investment of $2,000 US Dollars (USD) that returned a total profit of $350 USD in five years, with $100 USD returns in the first two years and $50 USD returns in the last three years, would have an average annual yield of 3.5%, with a total yield at the end of the five years of 17.5%. This average annual yield is a balance of 5% returns on investment in two good years, and 2.5% returns on investment in three poor years.
The difference between a current yield and a realized yield is another important distinction to make in the process of return on invested capital. The current yield is a clear percentage of growth in the investment before withdrawals or liquidation occur. Where interest or dividends are reinvested in the original total and taxes are paid on the investment when it is liquidated, a realized yield will be different from the expected yield that was promised to the investor when the financial instrument was purchased, and may be higher or lower than was expected. Due to such fluctuations, average annual yield is only a indicator of the direction in which an investment is headed, and cannot be entirely relied upon as a form of fixed income.
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