UNDERSTANDING INCOME RETURN

Last week we went through the rationale behind investing for income purposes and the need to create Replacement Income especially when working towards retirement. The next element we have to address is how to understand an Income Return and how to evaluate it against other types of returns. Generally a Return is the money you make over and above the cost of your investment. If you buy shares for Kes 100,000 and next year you sell them for Kes 150,000. Your return is Kes 50,000. You have made a return because you have sold your shares and pocketed the profit. In percentage terms you have made a return of 50% (Kes 50,000/Kes 100,000)

Aside from selling (in order to realise your profit) the other way to earn a return is if your investment is generating an income. For example if you buy a property worth Kes 1,000,000 and each year you receive Kes 100,000 in rent (approximately Kes 8,400 per month). You have not sold the property but every year you get an actual cash return of Kes 100,000 into your pocket. Your return per year is therefore 10% (Kes 100,000/Kes 1,000,000). This return i.e. Income Return is what is referred to as a YIELD. The term YIELD answers the question – What guaranteed Cash return will I get if I invest this money? Remember when waiting to sell, the return is not guaranteed until the date of sale. However with regular constant income, it is. YIELD therefore has nothing to do with whether the value goes up or down, but the actual money being received.

The concept of YIELD is used in various types of investments that are driven by income. This could be rental property, bonds and even companies (both public and private) in form of dividends. The stock market page will have a column titled Dividend Yield. It simply expresses your actual cash return (via a dividend) if you buy the share at a particular price. The company will pay that dividend irrespective of whether the share price goes up or down. When you are investing with the objective of income, the YIELD is what you will use to compare one investment against another. Let’s go back to the example of our property. Say you got another opportunity to buy a property for Kes 5,000,000 and it will give you rent of Kes 30,000 per month (Kes 360,000 per year). You may think to yourself that’s more money (Kes 30k as compared to Kes 10k). However the yield here is 7% (Kes 360,000/Kes 5,000,000) as compared to the 10% yield in the first property. If you have access to this money you are better of buying 5 of the first units and getting Kes 500,000 per year.

Capital gains have their place but at some point you will need your investments to generate an income. The YIELD may become far more important to you than the growth in value of the asset because that income is what will be sustaining you. To ensure you get the best opportunity for your money, always compare different assets using this YIELD especially if your objective is driven by the need to have passive income as opposed to growth in value.

Waceke Nduati- Omanga

waceke@centonomy.com | www.centonomy.com| Twitter @centonomy.