Investing is frequently filled with complicated jargon that can make it difficult to understand how your investments are actually performing. The Capital Gains Yield is one of these terms. While most brokerages calculate this number for you on all of your stocks, you should still learn what that calculation is based on and how to use it when determining which stocks to buy, keep and sell. You can also work with a financial advisor who can use their years of experience and skills to manage this process for you.
What Is Captial Gains Yield?
A Capital Gains Yield (CGY) is a percentage representing the increase in the price of an investment compared to its original price. The opposite of a CGY is a Capital Gains Loss (CGL), which is a percentage representing the decrease in the price of an investment compared to its original price. Both the CGY and the CGL numbers do not include dividends. To truly calculate the total return of an investment, you must include the CGY or CGL and dividend yield.
Many brokerages will provide the CGY and total return on investment for the stocks you hold. If you have an online account, this information is usually included in the account balance or portfolio positions tab.
When doing research on potential investments, the CGY, the total return on investments or both, is commonly shown for each potential stock. Many brokerages will allow you to see the CGY from different time horizons, which can be very helpful for long-term investors. Seeing the CGY or total return rate since inception for a given stock can help you make an educated decision on what to invest in.
Manually calculating CGY isn’t necessary anymore when many investment firms do it for you. But knowing how it’s calculated and how it works can help you understand your investments better and become a more confident investor.
How to Calculate Capital Gains Yield
Calculating a capital gains yield is very simple. You subtract the original price of a stock from the current price of a stock and divide the sum by the original price.
For example, if you buy a share of XYZ Successful Company on Jan. 1, 2022, for $100 and sell it for $120 on Dec. 31, 2022, then the CGY for that investment is 20%. 120 minus 100 equals 20. 20 divided by 100 is 20%.
Calculating a capital gains loss follows the exact same formula. Subtract the original price of a stock from the current price of a stock and divide the sum by the original price.
For example, if you buy a share of PQR Failing Company on Jan. 1, 2022, for $120 and sell it for $100 on Dec. 31, 2022, then the capital gains loss for that investment is 16.67%. 100 minus 120 divided by 120 is 16.67%.
How to Calculate Total Return On Investment
Calculating just the capital gains yield on an investment may not give you an accurate picture of your investment’s performance. While the CGY alone gives you a complete picture if a stock doesn’t pay dividends, it’s missing an important piece of the puzzle if a stock does pay dividends.
To calculate the total return on investment for a stock that pays dividends, you have to combine the dividend yield with the capital gains yield or loss of the stock.
To calculate the dividend yield, you must divide the annual dividends for a stock by the original price of the stock.
Total Return for Investments Without Dividends vs. With Dividends
Continuing our above example, the stock in XYZ Successful Company does not pay dividends, so the CGY of 20% is a complete picture of that stock’s performance.
In comparison, the stock in PQR Failing Company paid a quarterly dividend of $5, adding up to an annual dividend of $20. To determine the dividend yield we divide the annual dividends of $20 by the original purchase price of $120, giving us 16.67%. To get the total return we combine the dividend yield of 16.67% with the capital gains loss of 16.67% we calculated above, making the total return of this stock 0%.
Using Capital Gains Yield to Invest Wisely
When reviewing investment performance, remember that the capital gains yield is only a complete picture if dividends aren’t involved. If your investment strategy is to build passive income through dividends, you may want to focus more on the dividend yield. If your strategy is to have the greatest long-term growth possible, you’ll want to focus primarily on the total rate of return.
Working with an expert financial advisor can help you determine which strategy is best for your situation. They can also help you plan the timing of when you sell your stocks better.
In both of our examples above, holding on to the stocks for just a day longer would have made the difference between paying short-term vs. long-term capital gains on the profit. Profits on investments that are held for at least one year are taxed at a maximum federal rate of 20% while investments held for less than a year can be taxed as high as 37%.
The Bottom Line
A capital gains yield is a percentage used to show an investment’s appreciation in price. The CGY does not include dividend yields, so it should not be used to determine the performance of a stock that pays dividends. It can be a good tool to measure potential returns on investments without factoring in dividends and can help you choose the right asset allocation mix for your portfolio.
Tips for Investing
Analyzing your investments is important to routinely check in and make sure they are still helping you achieve your goals. A financial advisor can help you decide which assets are working and which new investments might be needed to reach your goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You may want to consider using SmartAsset’s free asset allocation calculator to help you choose a potential mix of assets for your portfolio.
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Source: https://finance.yahoo.com/news/calculate-total-return-investment-140017092.html