How you measure yield counts How you measure yield counts\images\insights\article\tape-measure-small.jpg July 10 2024 July 10 2024

How you measure yield counts

In fixed income, there’s quite a difference between current yield and yield-to-maturity.

Published July 10 2024
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Among the more complex elements of investing in fixed income is understanding the distinction between yield measures, such as current yield and yield-to-maturity (YTM). The subject typically arises in client conversations when they ask, "what is the current yield?” But that is not necessarily the right question. If investors are looking for a measure of expected annual total return on a bond or portfolio of bonds held to maturity, YTM is more telling. 

What is the difference? The current yield of an individual bond is simply its coupon divided by its price; for a portfolio of bonds, it’s the average coupon of all its holdings divided by their average current price. Both provide an approximation of the coupon component of total return. By comparison, YTM measures both price and coupon components of total return, providing an estimated average annual total return over the life of the bond or bond portfolio at a point in time. YTM does this by factoring in the impact of the bond price “pulling to par.” Par is the amount the issuer agreed to repay the person who purchased it. It is also called face value.

Pulling to par occurs over the lifetime of a bond that is trading at a premium or discount—higher or lower than its face value, respectively. The bond price will move so that it reaches par at maturity. This change in its dollar price is an important component of total return; omitting or including it can lead to stark differences between YTM and current yield. 

We believe looking at the YTM is a more reliable yield measure. In general, bonds priced at a premium above par will have a YTM that is less than current yield, and vice versa. The further the bond is priced above or below par, the wider the difference between current yield and YTM can be. 

The timing of clients’ confusion makes sense. Differences between current yield and YTM have widened over the last few years as the Federal Reserve rapidly raised interest rates. Each time the Fed hiked, the prices of bonds issued in the previous, low-rate regime decreased. Many higher-coupon bonds have been issued over the last couple of years, but lower-coupon, older bonds far outnumber them on the secondary market. This means that comparing the current yields of two bond portfolios could be misleading. One portfolio might own more recently issued bonds with high coupons trading above par, resulting in a greater current yield, but lower YTM.

The lesson here is that current yield does not tell the full story. Employing it might distort reality when looking for a measure of return or comparing two yields. Active managers focus on total return. Advisors and investors should, too. When assessing bond portfolios or individual bonds, evaluate both.

Tags Fixed Income . Interest Rates .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Current yield: The coupon divided by price. Portfolio current yield is the market value weighted average of the security level current yields.

Yield to Maturity (YTM): Used to determine the rate of return an investor would receive if a long-term, interest-bearing investment, such as a bond, is held to its maturity date. It takes into account purchase price, redemption value, time to maturity, coupon yield, and the time between interest payments.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. 

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