Effective Yield: Understanding and Calculating Annual Returns

You can calculate yields on your investments.

In the world of finance and investments, two types of yield are the periodic yield and the effective yield. The periodic yield is the yield for the period (i.e., month, semiannual), while the effective yield is the return every year. In general, analysts use the term "effective yield" to refer to the annual yield, which is helpful in comparing assets that pay more than once a year. Another term for effective yield is APY, or annual percentage yield.

Step 1

Determine the number of payment periods ("n") in a year. Some securities pay every six months, in which case the number of periods is two. In this example, the number of payment periods is 12 (monthly).

Step 2

Determine the interest rate ("i"). This is the nominal or stated interest rate on the security. For example, say you own a bond that pays 6 percent every month.

Step 3

Divide the interest rate (in decimal form) by the number of periods. In this example, .06 / 12 = .005.

Step 4

Find the sum of 1 + "i/n". The calculation is 1 + .005 = 1.005.

Step 5

Take the sum of the calculation in Step 4 to the exponent "n." The calculation is 1.005^12, or 1.061677812.

Step 6

Subtract 1 for the effective (annualized) yield. The calculation is 1.061677812 - 1 = .061677812, or 6.17 percent.