Is yield on cost (YOC) a useful metric?

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Riprap
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Is yield on cost (YOC) a useful metric?

Post by Riprap » Tue Mar 18, 2014 10:31 am

I have been reading the various dividend strategy threads and associated links over the last few months. Invariably, proponents raise the yield on cost (YOC) measure as an indication of how successful a dividend strategy can be; the higher, the better. Even Warren Buffett refers to yield on cost from time to time in his letters to shareholders lending credence to the YOC measure.

What say the collective wisdom of Bogleheads? Is YOC useful or not?

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Re: Is yield on cost (YOC) a useful metric?

Post by dbr » Tue Mar 18, 2014 10:45 am

Probably about as useful as total return on cost, in which measuring total return can show that the investor has had great results.

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Re: Is yield on cost (YOC) a useful metric?

Post by Orion » Tue Mar 18, 2014 11:38 am

One thing to be careful of is that in dividend-oriented forums, you'll see some people throw around great-sounding YOCs or personal yields in much the same way that some people on stock-picking forums always seem to have bought stocks at their bottoms. ie: the numbers seem awfully good but can you replicate them going forward?

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Tue Mar 18, 2014 12:26 pm

Riprap wrote:I have been reading the various dividend strategy threads and associated links over the last few months. Invariably, proponents raise the yield on cost (YOC) measure as an indication of how successful a dividend strategy can be; the higher, the better. Even Warren Buffett refers to yield on cost from time to time in his letters to shareholders lending credence to the YOC measure.

What say the collective wisdom of Bogleheads? Is YOC useful or not?
The below is most relevant to a dividend strategy in retirement where you are using a certain cash flow to fund your income withdrawals.

Yes, YOC is absolutely important, in cash flow applications, because this is your return on your investment, for the case where you are creating an income stream in retirement, much like the payout of an annuity.

This is not however the only thing that is important, how it changes over time is also important -- is it holding steady, or trending up or down.

In my retirement income bucket strategy I track three performance numbers, Yield on cost, current yield and the dollar gain or loss on the investment.

The YOC is of course the most important because this tells me in an instant if I am going to meet my income goals for the quarter and the year, since my strategy is a capital preservation strategy and not a total return strategy.

If you are NOT in retirement your goal should not be capital preservation, at least IMHO, but should be more focused on total return, where YOC plays only a minor role as somewhat of an indicator of whether you overpaid for an investment.

fd

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Re: Is yield on cost (YOC) a useful metric?

Post by Riprap » Tue Mar 18, 2014 2:40 pm

FinancialDave wrote:The YOC is of course the most important because this tells me in an instant if I am going to meet my income goals for the quarter and the year, since my strategy is a capital preservation strategy and not a total return strategy.
fd
I understand the importance of being able to forecast cash flows, however I don't see how the cost of the income producing asset is relevant. For cash flow projections, the dividend per share is the number I would use. In my mind the amount paid for the asset, which in this case is a dividend paying stock, is a sunk cost.

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Re: Is yield on cost (YOC) a useful metric?

Post by steve_14 » Tue Mar 18, 2014 2:44 pm

If it's something the public has access to and can trade on, it has no value. If it's something only you know, it's quite valuable.

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Re: Is yield on cost (YOC) a useful metric?

Post by bhsince87 » Tue Mar 18, 2014 4:33 pm

It’s interesting to track, but pretty useless, IMO.

Take my Apple shares as an example. My current YOC is about 110%. YAY!

Yes, I am actually earning more per share every year than I paid for each share. But what does that tell me, really? That I made a good decision 10-14 years ago?

It’s much more relevant that Apple is currently yielding 2.4%. I can actually do something useful with that number, like compare cash flows from Apple versus a bond or other investment.
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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Tue Mar 18, 2014 7:01 pm

Riprap wrote:
FinancialDave wrote:The YOC is of course the most important because this tells me in an instant if I am going to meet my income goals for the quarter and the year, since my strategy is a capital preservation strategy and not a total return strategy.
fd
I understand the importance of being able to forecast cash flows, however I don't see how the cost of the income producing asset is relevant. For cash flow projections, the dividend per share is the number I would use. In my mind the amount paid for the asset, which in this case is a dividend paying stock, is a sunk cost.
Of course the raw dividend $ tells you how much your cash flow is going to be, which is where the YOC value comes from. If you only look at the $ of dividend you have no idea in a portfolio how this investment is performing in comparison to your other 20 stocks or funds and you also want to be able to compare it over time. I also track any changes to any dividends up or down in the notes section of my spreadsheet.

The YOC metric gives you a percentage indication over time of how your original investment has been doing, which you can compare on common ground to any other investment. Since the divisor of the calculation is fixed (not subject to market price fluctuations) the YOC number is something that you could at least trend to see the growth rate of your dividends (either + or -).

Using the reported % dividend or yield calculated based on the current price of the stock is pretty useless, unless you need to make a decision to buy.

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Re: Is yield on cost (YOC) a useful metric?

Post by Ged » Tue Mar 18, 2014 7:38 pm

One of the problems I have with YOC is the upward bias due to inflation. The cost doesn't reflect inflated dollars but the yield does.

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Re: Is yield on cost (YOC) a useful metric?

Post by Karamatsu » Tue Mar 18, 2014 8:09 pm

I'm not sure there is a "collective wisdom" on the subject but I find that YOC distorts a person's view of their investments, making them think that a particular issue is worth more than it really is. Instead I think what matters is the value of your investments now, and the yield you are getting on that value. That is, current yield (or for bonds, maybe YTM depending on the circumstances).

Looking at YOC means you're comparing dividend now with a value that the investments had in the past. That may feel good (if the investment has increased in value), but it can lead to sub-optimal choices because when the share price experiences a run-up, the current yield on your investment may be below what the market is offering for better alternatives.

Of course, it's important to track gains/losses so you'll also be aware of the tax implications of a trade, but YOC... I'm not sure what good it is.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Tue Mar 18, 2014 8:17 pm

Ged wrote:One of the problems I have with YOC is the upward bias due to inflation. The cost doesn't reflect inflated dollars but the yield does.
What are you implying would be a better metric - certainly not using a current yield, which goes up and down on a minute by minute basis.

It does present a problem if you compare investments over different time periods, such as our Apple investor above. It makes the most sense comparing investments over the same time period.

Example:
On Jan 1 you make two investments - AAPL yielding 3% and a bond fund yielding 3% (at the time). Let's say you invested $10,000 in each.

On December 31 you evaluate whether you made the right choice, you do this by essentially doing a YOC calculation.

Fictitious numbers for this example:
APPL paid you $300 for the year.
The bond fund paid out monthly payments which totaled $275. Bond funds rolled over higher yielding bonds and had to substitute lower yielding new funds.

Therefore even though when you bought the investments you thought you were going to get 3%, you got 3% yield on your investment with the Apple shares, but only 2.75% with the bond fund.

Also at the end of the year because of interest rate fluctuations both are still reporting 3% current yield.

Now at the end of the year, which turned out to be the better investment, how do you determine if you keep one or both of them, do you rely only on what Morningstar reports as the current yield, or do you look at the expected cash flow (which is really a YOC calculation?)



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Last edited by FinancialDave on Tue Mar 18, 2014 8:41 pm, edited 3 times in total.
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Re: Is yield on cost (YOC) a useful metric?

Post by Calm Man » Tue Mar 18, 2014 8:26 pm

To me, YOC is less than meaningless. It will go up almost by definition the longer you hold an asset if the asset simply moves in step with the market. The person who is bragging of a yield on cost of 500% may be holding a share of stock since 1950.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Tue Mar 18, 2014 8:45 pm

Calm Man wrote:To me, YOC is less than meaningless. It will go up almost by definition the longer you hold an asset if the asset simply moves in step with the market. The person who is bragging of a yield on cost of 500% may be holding a share of stock since 1950.
Then his only usefulness of that 500% is to compare it to his other investments he also bought in 1950.

By the way this type of calculation is done by almost every company and is called ROI.

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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Wed Mar 19, 2014 1:19 pm

Personally, I don't see any value to considering yield on cost. I can't change what I bought/when I bought it. The bottom line is that I am presently holding a variety of investments that have returned various amounts since I purchased them. The only thing I can do is to change what I currently own though buying and selling. The problem is, like the rest of you, I don't know what the returns of my various investments will be going forward (we can perhaps agree to except the holding of individual US treasuries which are considered risk free and so I can know ahead of time what the return will be only because I can rule out default (theoretically)).

So, whatever I did or didn't pay for AAPL or Vanguard total market, etc. is irrelevant to how these investments will fare going forward which is really the only thing that matters now.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Wed Mar 19, 2014 3:42 pm

Randolph wrote:Personally, I don't see any value to considering yield on cost. I can't change what I bought/when I bought it. The bottom line is that I am presently holding a variety of investments that have returned various amounts since I purchased them. The only thing I can do is to change what I currently own though buying and selling. The problem is, like the rest of you, I don't know what the returns of my various investments will be going forward (we can perhaps agree to except the holding of individual US treasuries which are considered risk free and so I can know ahead of time what the return will be only because I can rule out default (theoretically)).

So, whatever I did or didn't pay for AAPL or Vanguard total market, etc. is irrelevant to how these investments will fare going forward which is really the only thing that matters now.
It is true that none of us are fortune tellers.

Since you don't appear to be in retirement and don't appear to be needing income, YOC really has no use for you.

Knowing how to compare the growth rate of your income component (a YOC type calculation) of a retirement portfolio is however not irrelevant. This is essentially how the age old 4% withdrawal rate works -- it is a yield on cost type of calculation --- of course from some of the conversations on this subject most don't understand this either.

The short story is that the most common usage of the 4% rule means that you take the total size of your retirement account on the day of your retirement -- this becomes your anchor point (cost) for the withdraw calculation. You calculate 4% of this cost and this is your starting point. Say this number is $40,000, this is year 1 withdraw rate (4% yield/withdraw on your cost). So to break even (hold your principal constant you need a YOC in year 1 of 4%. Year 2 you inflate the $40,000 (let's use 2%) so now you have $40,800 needed from your original investment (cost) or a 4.08% YOC from your original investment. Year 3 - more of the same, your YOC needs to be 4.16% to break even.

The assumption being no added money has flowed into the account and all original investments have remained unchanged.

Now granted most do not generate their retirement income by buying a set of investments and holding them with the intent of only living off the income - many will sell some of the growth of their account and live off of that as well. This selling of the growth component could also be considered a YOC from your original investment at the time your retirement started.

Unlike, my comment above where YOC is not of much consequence in the accumulation phase of your life, if you don't understand YOC in retirement, you CAN go broke, because in the case where no new money is coming into your account your cost or "anchor point" is fixed and the yield you get on it (whether through income or "selling the growth") IS the all important metric.

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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Wed Mar 19, 2014 7:27 pm

FinancialDave wrote: It makes the most sense comparing investments over the same time period.

Example:
On Jan 1 you make two investments - AAPL yielding 3% and a bond fund yielding 3% (at the time). Let's say you invested $10,000 in each.

On December 31 you evaluate whether you made the right choice, you do this by essentially doing a YOC calculation.

Fictitious numbers for this example:
APPL paid you $300 for the year.
The bond fund paid out monthly payments which totaled $275. Bond funds rolled over higher yielding bonds and had to substitute lower yielding new funds.

Therefore even though when you bought the investments you thought you were going to get 3%, you got 3% yield on your investment with the Apple shares, but only 2.75% with the bond fund.

Also at the end of the year because of interest rate fluctuations both are still reporting 3% current yield.

Now at the end of the year, which turned out to be the better investment, how do you determine if you keep one or both of them, do you rely only on what Morningstar reports as the current yield, or do you look at the expected cash flow (which is really a YOC calculation?)
I am not denying that you may get a great deal of enjoyment out of calculating your yield on cost. I am also not going to deny that many people, especially in retirement, use the income from their investments to fund their current expenses. But, I don't quite follow your logic.
FinancialDave wrote: On December 31 you evaluate whether you made the right choice, you do this by essentially doing a YOC calculation.
First, I would suggest that yield on cost is not going to tell you whether you made the right choice, but rather, total return will tell you which investment performed better. But, even if we agree that we can tell which investment performed better during the period in question (Jan 1 to Dec 31), I do not understand how your next statement follows from that:
FinancialDave wrote: Now at the end of the year, which turned out to be the better investment, how do you determine if you keep one or both of them, do you rely only on what Morningstar reports as the current yield, or do you look at the expected cash flow (which is really a YOC calculation?)
I don't understand how you can use last year's performance to determine if you keep one or both of them. What matters is what happens now and in the future. You don't know what the dividend will be. Yes, you can guess, based on some extrapolation from the past. But dividends may grow faster than you are anticipating, or slower, or they may be cut or even eliminated. The bottom line is that you don't know. You don't know what will happen to interest rates (and thus your bond prices) either, or whether any of your bonds will default (I know this can be mitigated with a Treasury bond ladder to give you something close to certainty). These are the things that matter going forward.

Also, it may be that I don't understand what a 4% SWR really means, but my understanding is that withdrawing at this rate has meant that you would not likely run your account down to zero in most stock and bond market gyrations (depending on your allocation and based again on historical precedent of what can happen over N years). In some years your holdings will decline in value and in others they may increase.
FinancialDave wrote: Now granted most do not generate their retirement income by buying a set of investments and holding them with the intent of only living off the income - many will sell some of the growth of their account and live off of that as well. This selling of the growth component could also be considered a YOC from your original investment at the time your retirement started.

Unlike, my comment above where YOC is not of much consequence in the accumulation phase of your life, if you don't understand YOC in retirement, you CAN go broke, because in the case where no new money is coming into your account your cost or "anchor point" is fixed and the yield you get on it (whether through income or "selling the growth") IS the all important metric.
It seems like you CAN go broke even when you full well understand the concept of Yield on Cost. Just because you *need* to earn 4% to avoid drawing down your balance does not guarantee that you will in fact be able to do so. When you mention "yield" as income + growth, it seems as if you are saying the same thing as "total return". Am I understanding that correctly? In any event, both the income and growth can fluctuate in ways that may be detrimental to your portfolio. You may have set your anchor point and 4% withdrawal rate based on the exact amount in your account on the day you retired, but that was then, and you might need to make some changes to your plan. Hopefully you have a big enough cushion that even a serious downturn does not leave you in a situation where you will run out of money.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Thu Mar 20, 2014 10:15 am

I don't understand how you can use last year's performance to determine if you keep one or both of them
Randolph,


When you buy an investment, especially something other than an index fund, you have to have some idea of what would cause you to sell that investment. Most all of these reasons are based on facts, and I would hope are somehow (at least loosely) based on the price you paid for the investment. Secondly, my illustration is based on someone's retirement goal of generating income to live off of.

If you can't base the above off of the history of the investments you bought ("last years performance, last weeks performance, ...) the only thing I can think of is you might be projecting some future performance??

YOC over a defined time period, is only one metric I would use, but any other metric, such as the dividend was cut, is also going to be based on past performance.

So yes, every decision I make on whether to sell something is based on some "past performance," even if that past performance is something so simple as the price dropped because a dividend cut was announced. Or maybe the past performance is just that investment 1 seems to have a more constant and predictable income than investment 2.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Thu Mar 20, 2014 10:32 am

First, I would suggest that yield on cost is not going to tell you whether you made the right choice, but rather, total return will tell you which investment performed better
I don't want to get into a spat about whether total return, or income based retirement planning is better, because I actually have two retirement buckets and I use one strategy in one and the other strategy in the other.

The key is that my strategy and what I am discussing here is only related to the income bucket, where my specific goal is to maintain the capital in the bucket, or more correctly maintain the income generation in the bucket. In other words I have a fixed amount of money and I don't plan on adding to it from the growth (total return) bucket. Therefore maintaining a constant or increasing yield on my original cost is what matters. This is one way to track whether this strategy is working long term. The other way to track it is to just track the cash flow per quarter, which I also do, and since I have not changed the original investment, this is just tracking the YOC using different units of dollars rather than a percentage.

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Re: Is yield on cost (YOC) a useful metric?

Post by ogd » Thu Mar 20, 2014 12:27 pm

I don't think it's very useful, because it's backward-looking. It's mostly a way to congratulate yourself on investing at good times or for long periods of time, or in FinancialDave's words, "to see whether your strategy is working". In this regard it's the equivalent of personal investment return numbers; the value is mostly in convincing you to stay the course. But it has very little information going forward. For an extreme example, you might own old long bonds that pay 10% coupons that you bought at par, so a YoC that seem unbeatable, but whose actual yield is less than 1% at current market prices and duration and you'd be well advised to sell them.

The same can happen with stocks bought in 2009 -- a great move to be sure, but they are not intrinsically better (or in any way different) than similar stocks bought in 2007 when it comes to evaluating them in 2014, despite having probably 2x the "yield on cost". Nor does it mean that a strategy that produced those kinds of yields can continue to do so going forward, because stocks can't be bought at 2009 prices anymore.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 10:51 am

ogd wrote:I don't think it's very useful, because it's backward-looking. It's mostly a way to congratulate yourself on investing at good times or for long periods of time, or in FinancialDave's words, "to see whether your strategy is working". In this regard it's the equivalent of personal investment return numbers; the value is mostly in convincing you to stay the course. But it has very little information going forward. For an extreme example, you might own old long bonds that pay 10% coupons that you bought at par, so a YoC that seem unbeatable, but whose actual yield is less than 1% at current market prices and duration and you'd be well advised to sell them.

The same can happen with stocks bought in 2009 -- a great move to be sure, but they are not intrinsically better (or in any way different) than similar stocks bought in 2007 when it comes to evaluating them in 2014, despite having probably 2x the "yield on cost". Nor does it mean that a strategy that produced those kinds of yields can continue to do so going forward, because stocks can't be bought at 2009 prices anymore.
I think a major point must be - how can you know if something current is better if you don't know what you have (based on past performance.)

Here is where I think bond fund investors "go off the rails" -- they are constantly impressed by the "current yield" numbers reported by the fund and fail to see that even though the current yield may be going up, their CASH FLOW is going down.

Maybe this concept is hard to grasp for those that are not in retirement - but cash flow "efficiency" if you will, requires a calculation (yield) based on the cost of your investment (whenever that was, yesterday, or 5 years ago) and the income, which is essentially a YOC metric.

Since we are talking about a metric to measure cash flow, I would also contend that the person who doesn't know how to evaluate past performance on some common ground is destined to, at the very least, not be able to make the best use of his/her money held.

Granted, making the best use of your money may not be your goal, because you have already determined you have more than enough - but I certainly have heard a few responses on another thread of early retirement that may indicate otherwise.

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Re: Is yield on cost (YOC) a useful metric?

Post by Riprap » Fri Mar 21, 2014 11:15 am

FinancialDave wrote:Maybe this concept is hard to grasp for those that are not in retirement - but cash flow "efficiency" if you will, requires a calculation (yield) based on the cost of your investment (whenever that was, yesterday, or 5 years ago) and the income, which is essentially a YOC metric.

Since we are talking about a metric to measure cash flow, I would also contend that the person who doesn't know how to evaluate past performance on some common ground is destined to, at the very least, not be able to make the best use of his/her money held.

Granted, making the best use of your money may not be your goal, because you have already determined you have more than enough - but I certainly have heard a few responses on another thread of early retirement that may indicate otherwise.
Financial Dave,

As the OP, I appreciate your contribution to this thread. Perhaps I am blinded by the concept of sunk costs, but I am having a hard time grasping how you would actually utilize YOC in decision making. Perhaps you can provide an example. Say two dividend yielding investments were purchased on the same day and now have vastly different YOCs. All we know is that the investment with the higher YOC has generated more dividend income up to the present. Assuming the YOC rate holds, I can see how YOC might provide a clue as to what dividend flow can be expected in the future. You seem to be saying in the quote above that failure to make a YOC comparison could lead one to make suboptimal use of his money.

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Re: Is yield on cost (YOC) a useful metric?

Post by ogd » Fri Mar 21, 2014 11:49 am

FinancialDave wrote:Here is where I think bond fund investors "go off the rails" -- they are constantly impressed by the "current yield" numbers reported by the fund and fail to see that even though the current yield may be going up, their CASH FLOW is going down.
Fd: you might be venturing outside your area of competency here. It's well known that bonds return money through both coupons and capital return; in fact, if the tax regulations designed to ensure you take at least some of the return as income did not exist, such as OID, I'd take it all as capital return and never pay another dime in income tax on bond interest again, and surely most or all funds would do this for me as well. A 10% coupon bond from the 80s is a substantially worse yield provider than a zero coupon bond of longer maturity that can be bought with the same money. You must find the latter unjustifiable in your approach, btw, whereas in some hyper-precise spending strategies zero coupon bonds are the instrument of choice.

When a Treasury fund tells you it has a SEC yield of 2%, that truly means it's sitting on instruments that generate that return going forward with absolute certainty (nominally). If it only pays 1% as dividend and the rest as capital gains, I treat it as a tax gift and so should anyone with a tax bracket higher than capital gains tax rates. I don't need the other 1% right now, but if I did I'd have no qualms about selling shares for the rest because the SEC yield tells me the fund can support those withdrawals.

But going back to said area of competency: take Exxon shares bought in early 2009, yield on cost is something like 4.5% by my calculations. How is this useful? Are these shares substantially better for income than Chevron shares at current prices yielding 3.46%? No -- in fact exchanging from said Exxon shares to Chevron will increase my yield by 1.3x, and I have to make a judgment call the other way, is the perceived higher quality of Exxon (by the market) worth staying and accepting a lower yield. I really should be looking at Exxon's current yield, which is 2.66%.

Or is it the case that the 4.5% tells me something about my strategies going forward? I don't think so. Exxon quality can no longer be bought at those prices, and once again I should look at what's available in the market. You say that this is a good way to self-evaluate and self-tune, but really I regard the immense return on shares bought in 2009 as a stroke of luck and I take no credit for it. Suppose I get a windfall tomorrow to add to my nest egg -- I can't possibly expect those returns anymore.

Or is it the case that the 4.5% tells me about where I stand with regards to sustainable spending, assuming I started spending in 2009? You seem to be making this point to some degree, but in my mind there's a much simpler way to do this -- look at current value and current yield. There's no need to anchor to that point. Looking at present data has the advantage of incorporating any deviations from your original plan, for example you might have spent less than you expected.

So I don't know why you'd put an emphasis at yield on cost. It might be an interesting piece of data, but I don't see why it's useful as a metric.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 12:32 pm

Riprap,
I am not saying that YOC is the only metric you need to use, and I am certainly not saying it is something you would use in the accumulation phase prior to retirement - because in that world your goal is not to create income but total return.

Ok, for an example.

I start retirement and just to be fair to a diverse group of strategies, some of my retirement income will come by selling my appreciated growth and some of it will be generated as cash flow from an investment of bonds or dividend paying stocks (3 different ways to generate income -- which to broaden the definition of YOC slightly are all ways to generate yield from your investments (cost). Your question however is just about the dividend portion of these 3, since this is the common usage of the term YOC.

We will talk about just the dividend income -- how much income you get is directly affected by your cost point (stock price) and the current yield (dividend.) You make your original decision to buy based on a number of parameters, just some of which are current yield, how you perceive the quality of the yield, whether the yield is expected to grow in the future, the dividend history over the last 10-40 years, etc.

So you go out and over 1 months time you buy 10 stocks. You put this cost and current dividend into your spreadsheet, you create a column which you call YOC. In my spreadsheet this column is actually YOC per year and is for most investments the calculation (DIV x 4) /cost. My spreadsheet has various other columns which track other metrics such as cash flow, current yield, gain or loss of market value, and number of years dividend has increased, but let's concentrate on the reason for YOC.

So at the end of the month I have 10 stocks with say YOC numbers of from 3% to 11% and a total for the portfolio of 6%. How do I use these numbers.

Let's say at the end of year two the YOC numbers are in a range of 4% to 10%. Current yields move all over the map based on daily price fluctuations so they are of no use to me except if I need to make a decision to sell or buy, but one way YOC is valuable is to compare what happens between investments over time. At a glance from my new range of 4-10%, what I can see is that the dividends on the low end have increased (higher quality dividend payers that have been doing it for many years) and the highest dividend payer (probably a REIT) has been cut. By seeing the YOC numbers I can instantly see where the yield has gone since I have owned it, by knowing what it was on previous years or months. The magnitude of the change is reflected in the cash flow totals. By adding a column for initial YOC vs current YOC you can calculate the growth rate of your investment.

Hope that helps.

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Re: Is yield on cost (YOC) a useful metric?

Post by Riprap » Fri Mar 21, 2014 12:39 pm

Thank you Financial Dave. Sounds as if you have a good handle on your retirement investments.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 1:01 pm

But going back to said area of competency: take Exxon shares bought in early 2009, yield on cost is something like 4.5% by my calculations. How is this useful? Are these shares substantially better for income than Chevron shares at current prices yielding 3.46%? No -- in fact exchanging from said Exxon shares to Chevron will increase my yield by 1.3x, and I have to make a judgment call the other way, is the perceived higher quality of Exxon (by the market) worth staying and accepting a lower yield. I really should be looking at Exxon's current yield, which is 2.66%.
It is not useful at all in itself to determine whether Chevron is a better investment (from a cash flow / income basis) by just looking at Chevron current yield - which is part of my point!

I can not market time the current yields of Chevron or Exxon, and investors should not either.

What you are suggesting is you would like to buy and sell your stocks based on market fluctuations, not yield quality. In other words without regard to yield growth.

fd
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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Fri Mar 21, 2014 1:54 pm

FinancialDave wrote: I am not saying that YOC is the only metric you need to use, and I am certainly not saying it is something you would use in the accumulation phase prior to retirement - because in that world your goal is not to create income but total return.

Ok, for an example.

We will talk about just the dividend income -- how much income you get is directly affected by your cost point (stock price) and the current yield (dividend.) You make your original decision to buy based on a number of parameters, just some of which are current yield, how you perceive the quality of the yield, whether the yield is expected to grow in the future, the dividend history over the last 10-40 years, etc.

So you go out and over 1 months time you buy 10 stocks. You put this cost and current dividend into your spreadsheet, you create a column which you call YOC. In my spreadsheet this column is actually YOC per year and is for most investments the calculation (DIV x 4) /cost. My spreadsheet has various other columns which track other metrics such as cash flow, current yield, gain or loss of market value, and number of years dividend has increased, but let's concentrate on the reason for YOC.

So at the end of the month I have 10 stocks with say YOC numbers of from 3% to 11% and a total for the portfolio of 6%. How do I use these numbers.

Let's say at the end of year two the YOC numbers are in a range of 4% to 10%. Current yields move all over the map based on daily price fluctuations so they are of no use to me except if I need to make a decision to sell or buy, but one way YOC is valuable is to compare what happens between investments over time. At a glance from my new range of 4-10%, what I can see is that the dividends on the low end have increased (higher quality dividend payers that have been doing it for many years) and the highest dividend payer (probably a REIT) has been cut. By seeing the YOC numbers I can instantly see where the yield has gone since I have owned it, by knowing what it was on previous years or months. The magnitude of the change is reflected in the cash flow totals. By adding a column for initial YOC vs current YOC you can calculate the growth rate of your investment.

Hope that helps.

fd
fd,

I would not try to tell you how to manage your retirement, but at the risk of making myself obnoxious, I would like to propose that you could replicate the information I think you are trying to capture in your spreadsheet without any reference to yield-on-cost or the initial purchase price of any of your holdings.
FinancialDave wrote: We will talk about just the dividend income -- how much income you get is directly affected by your cost point (stock price) and the current yield (dividend.)
I think it is more clear to state: how much income you get is directly affected by the number of shares you purchase and current amount of the dividend.

Let's say as fd* (the hypothetical financial dave) you go out and buy your 10 stocks (or any other holding of your choice). Now, in your spreadsheet, you just include the name of the stock, the number of shares, and the current payment AMOUNT (e.g. the dividend for a specific stock). No reference is made to how much you paid for that investment. If you are concerned with cash flows, what you care about is not the "yield" but the total dollar income: the current payment amount (dividend) for each holding times the number of shares you own of that particular issue.

Again, you will not follow or care about "daily price fluctuations" since they are of no use to you. All you are concerned with is the amount of money being generated.

At the end of year two (or any other time frame of interest), you may have different values for the current payment AMOUNT of each holding. You can see that some of your holdings are paying more, and some perhaps will be paying less. You can see which one's increased/decreased and by exactly how much. You can sum the total and find out how much more (or less) income these particular 10 holdings are generating than they were in the past. Is it more? Is it enough? If you have a column to keep the original AMOUNT, you can calculate the growth rate of your income, as you have been doing.

If you bought these investments solely for the income they provide, you do not need to reference in any way the original cost of those investments, but just the amount of income they are providing. If they are providing enough income, great. If they are not, you will have to make a decision! Do you sell one or more of your holdings and buy something else? Which one's should you sell, and what should you buy? Now, you mentioned that "daily price fluctuations... are of no use to me except if I need to make a decision to sell or buy". Well, it is time to sell and buy and the only thing that matters now is the current price. Yield on cost is not going to help you out at all here.

I will add that your purchase price may have an effect on which holdings you choose to sell to the extent that there may be tax implications (perhaps you can harvest a tax loss, or you want to avoid selling something that would generate too much of a tax due to capital gain).

If this way of thinking about the situation does not help you fd, then feel free to ignore it either in part or in its entirety. Perhaps it will make sense to someone else. Or maybe it only makes sense to me?
Last edited by Randolph on Sat Mar 22, 2014 10:16 am, edited 1 time in total.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 2:10 pm

Fd: you might be venturing outside your area of competency here. It's well known that bonds return money through both coupons and capital return; in fact, if the tax regulations designed to ensure you take at least some of the return as income did not exist, such as OID, I'd take it all as capital return and never pay another dime in income tax on bond interest again, and surely most or all funds would do this for me as well. A 10% coupon bond from the 80s is a substantially worse yield provider than a zero coupon bond of longer maturity that can be bought with the same money. You must find the latter unjustifiable in your approach, btw, whereas in some hyper-precise spending strategies zero coupon bonds are the instrument of choice.
ogd,
I will give you "some" points on this one especially since for 30 years prior to retirement I didn't own a single bond or bond fund (well maybe some EE bonds.) My focus was on growth.

However, I like to supplement knowledge gained from printed matter, this forum, and others, by doing. By that I mean analyzing the results of my investment decisions. To that end, my retirement "history" is but on year 3, so the verdict is still out on the final results. Let me explain how YOC will help explain to me whether bonds or stock dividends would have been the smarter choice for the income portion and will in fact give me a year by year running total.

In my retirement income bucket along with 20 stocks and some cash are 5 very minor positions in a cross section of TROWE bond funds that cover 5 different asset classes, such as Emerging markets, TIPS, Corporates, and two other flavors of Intermediates.

Now I do realize that bonds are measured by SEC yields, current yields, and also can throw of capital gains, but from my simplistic viewpoint these are all forms of cash flow based on my original cost, so I can calculate a YOC number to compare to my other investments. They also don't matter since they are inside an IRA. There may actually become a time where the outlook for bond cash flow can replace some of the lower yielding stock dividends, but in my mind it depends not only on the current yield but the growth rate possibilities.

This does bring up one short fall on my original spreadsheet - whether it's bonds or stock dividends, both will occasionally throw off varying amounts of cash beyond the quarterly or monthly distributions, from either capital gains or special dividends. This can be substantial in some cases, which you will not see by looking at any current yield metrics. While I do capture these distributions in my spreadsheet, I don't total them up to define what might be called a current year YOC metric. Time for an enhancement to my spreadsheet.

fd
Last edited by FinancialDave on Fri Mar 21, 2014 2:31 pm, edited 1 time in total.
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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 2:20 pm

If this way of thinking about the situation does not help you fd, then feel free to ignore it either in part or in its entirety. Perhaps it will make sense to someone else. Or maybe it only makes sense to me?
Randolph,
It all makes perfect sense to me, and all that data is in my spreadsheet, so that when and if I need to make a change (to improve my cash flow) I can do so. It's just that part of that decision, at least for me, should be made based on the growth rate of the dividend over time, which comes easily by comparing initial YOC to current YOC, but of course could be visualized in an absolute sort of way looking at two other pieces of information such as "gain or loss on investment" (price gain or loss) and divided history.
If you are concerned with cash flows, what you care about is not the "yield" but the total dollar income: the current payment amount (dividend) for each holding times the number of shares you own of that particular issue.
You are correct in regard to the fact that if I need $1000 of cash flow I want to replace it with something that gets me that cash flow - but the goal would be to compare "yields" of my various options and the quality of those yields over time to choose the correct option, not just choose the Exxon or Chevron on the list and buy enough shares to get me there.

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Re: Is yield on cost (YOC) a useful metric?

Post by ogd » Fri Mar 21, 2014 2:32 pm

FinancialDave wrote:It is not useful at all in itself to determine whether Chevron is a better investment (from a cash flow / income basis) by just looking at Chevron current yield - which is part of my point!

I can not market time the current yields of Chevron or Exxon, and investors should not either.

What you are suggesting is you would like to buy and sell your stocks based on market fluctuations, not yield quality. In other words without regard to yield growth.

fd
Well I'm not an income investor and my days of buying individual stocks are long gone. But you are -- and surely if Exxon were to freeze or drop dividends to the point where 10 years down the road it's a dividend stock only, you'd get rid of it despite the outstanding yield on cost of shares bought in 2009. This wouldn't be about market fluctuations, but a change in the nature of Exxon stocks as far as dividend investors are concerned.

As for bonds and capital return -- both tax regulations and what I assume is a desire of sound, conservative funds to have sustainable income combine to eventually drive cash flows close to SEC yields, no more no less, meaning in the long term looking only at cash flows is not far off the mark. However, in times of steep and unstable yield curves the two will temporarily deviate, and when the difference is in favor of capital gains I treat it like a gift, as I was saying, rather than thinking my funds are letting me down. You might not care about the tax implications in an IRA, but some investors do and certainly the IRS does and funds have to abide by both.

In an extreme example, Vanguards hyper-long fund EDV is composed entirely of zero coupon bonds. Without tax rules, this fund would yield exactly zero, but as it is it's one of the highest yielding Treasury funds available. How's that for gains / income convertibility :)

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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Fri Mar 21, 2014 3:27 pm

FinancialDave wrote:
You are correct in regard to the fact that if I need $1000 of cash flow I want to replace it with something that gets me that cash flow - but the goal would be to compare "yields" of my various options and the quality of those yields over time to choose the correct option, not just choose the Exxon or Chevron on the list and buy enough shares to get me there.

fd
Compare the above statement [emphasis added] with what you include in your signature line:

"Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!"

I will submit again that your initial purchase price, and even the dividend history of any holding over a particular period of time, will do nothing to enable you to choose the "correct" option going forward. Nevertheless, I wish you, and all the other investors out there, whatever their methods, the best of luck in meeting their financial needs.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Fri Mar 21, 2014 7:56 pm

I will submit again that your initial purchase price, and even the dividend history of any holding over a particular period of time, will do nothing to enable you to choose the "correct" option going forward
Randolph,

I will actually agree that there is little I can do to pick the "correct" option (meaning best future income) as I cannot predict the future.

However, if I have 10 investments for a period of 10 years, 9 of them have had a dividend growth rate of 5% and one of them has a dividend growth rate of 2%, however, all cash flows are currently equal, how do I know which one should be replaced? On this particular day the stock prices are such that all the current yields are equal but my cash flow has deteriorated to the point of needing to be shored up.

fd
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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Sat Mar 22, 2014 9:08 am

FinancialDave wrote:[

However, if I have 10 investments for a period of 10 years, 9 of them have had a dividend growth rate of 5% and one of them has a dividend growth rate of 2%, however, all cash flows are currently equal, how do I know which one should be replaced? On this particular day the stock prices are such that all the current yields are equal but my cash flow has deteriorated to the point of needing to be shored up.

fd
fd,

You would like to know what is essentially unknowable. If I could answer that question for you, I could become fabulously wealthy. Not being able to answer that question is the reason people on this forum support passive index investing.

If you are going to buy individual stocks, paraphrasing/slightly altering a well worn expression: you pays your money and you takes your chances.

Your choices may turn out just fine. They can still be "fine" (in the sense of providing for your financial needs) even if they lag the market as a whole (which they may or may not do).

Note that your comment above (referring to dividend growth rates) has nothing to do with "yield on cost" which was what the original question was about.

There are two issues that seem to have become intertwined in this discussion: (1) is "yield on cost" a useful metric? (2) will knowing anything about "yield on cost" (or any other quantifiable financial parameter based on available data) help determine the best actions going forward?

I will again answer (1) no (though I know it gives great pleasure to those who employ it, so I suppose technically it has some non-financial utility) (2) no, there are no crystal balls (though you can try to invest based on statistical measures and hope that will give you the best odds of success).

The last point I would like to (re)make is that if you include "income and capital appreciation" as part of yield-on-cost, then in reality, you are looking at "total return". That's all well and good, but it isn't the same thing as what most dividend investors mean when they refer to yield-on-cost (which is the income received divided by their specific purchase price). Seeing and contemplating this (often large) YOC number is what gives people a good bit of pleasure, but it is not a useful metric from an investing standpoint. It is an historic artifact.

Even though I know (and believe) the arguments against buying individual stocks, I still own individual stocks. Yes, it's "irrational" but I am ok with that. I don't think it's immoral or a character flaw. There are times when my portfolio performs better than the market and periods where it does not. Who can tell what the final outcome will be (other than in the long run, we are all dead).

In closing, again I would like to wish you and all the other investors here the best of success in meeting their financial needs, however it is achieved (so long as its legal).

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Re: Is yield on cost (YOC) a useful metric?

Post by Riprap » Sat Mar 22, 2014 9:50 am

Randolph,

I have enjoyed your posts on this thread.

I started this thread because YOC doesn't make a whole lot of sense to me, yet it is widely discussed among the dividend investing crowd. Although it seems to me that YOC involves some sort of cognitive bias (perhaps anchoring?), the possibility exists that my reasoning and thinking is flawed and that I'm failing to understand an important concept. Hence, my original post.

Is this a behavioral finance phenomenon?

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Re: Is yield on cost (YOC) a useful metric?

Post by dbr » Sat Mar 22, 2014 10:10 am

Riprap wrote:Randolph,

I have enjoyed your posts on this thread.

I started this thread because YOC doesn't make a whole lot of sense to me, yet it is widely discussed among the dividend investing crowd. Although it seems to me that YOC involves some sort of cognitive bias (perhaps anchoring?), the possibility exists that my reasoning and thinking is flawed and that I'm failing to understand an important concept. Hence, my original post.

Is this a behavioral finance phenomenon?
In my opinion it certainly is.

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Re: Is yield on cost (YOC) a useful metric?

Post by Randolph » Sat Mar 22, 2014 10:57 am

Riprap wrote:
I started this thread because YOC doesn't make a whole lot of sense to me, yet it is widely discussed among the dividend investing crowd. Although it seems to me that YOC involves some sort of cognitive bias (perhaps anchoring?), the possibility exists that my reasoning and thinking is flawed and that I'm failing to understand an important concept. Hence, my original post.

Is this a behavioral finance phenomenon?
I suppose in some sense it is "a behavioral finance" phenomenon, insofar as it "causes" people to view or evaluate a financial situation in a way that is not supported by the "evidence".

Based on my limited and non-scientifically-rigorous observations, the way most dividend investors use yield-on-cost is to demonstrate the superiority of a dividend investing strategy based on buying shares of specific companies that will grow their dividend over time (note: financial dave appears to be using it differently as he explained above, as a kind of short-hand way to compare to each other how various of his holdings have performed over a particular period of time, so this discussion does not necessarily apply to him).

So, you buy shares of company XYZ at a price P. The dividend is typically paid quarterly and raised once annually (this is much more of a US phenomenon, as Euro firms would often have varying dividend amounts paid semi-annually, depending on how business went in that year). So, while you were originally receiving say $100 per year on your $5000 initial investment (2% yield on cost), over a long period of time, that has now grown to over $1000 per year. Given that you paid $5000, that gives you a yield on cost of 20% !!!! Where can you get an investment like that today??!!!! Answer (according to YOC dividend investors): by buying stocks that, while yielding only 2% today, will eventually give you a yield on cost of 20% or 50% or 100% by consistently raising their dividend over time.

The evidence, though, is that what really matters is TOTAL return, of which dividends are certainly a part. Dividend based strategies (again, according to the research) do not explain total returns in a meaningful way. My terminology may not be right here, but dividends are not a "factor" that explain returns, and you are not necessarily going to "beat the market" by following a dividend strategy.

I would not call this phenomenon "anchoring". Anchoring seems to refer to giving weight to a price that is in some sense arbitrary. I don't know where the term originated in the behavioral finance literature, but the research I am familiar with on "anchoring" has to do with taking a set of objects, giving them an arbitrary price (based on the last two digits of your social security number) and asking people whether they would or would not pay that much for each of the objects (yes or no). This is the arbitrary "anchor" price. THEN, when people are asked what they WOULD pay for the objects, people with higher social security digits (higher "anchor" prices) consistently offer more than those with lower digits!

There are other aspects of the "anchoring" phenomenon, or how it may affect people in markets: people holding onto a losing position until it gets back to even and they can get out without a loss, people buying stock after it drops a certain amount from some past price they first saw thinking that this must now represent a good deal (true, it is a better deal, but it still may be a very bad deal), etc.

I hope this helps.

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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Sat Mar 22, 2014 12:48 pm

Randolph wrote: I think it is more clear to state: how much income you get is directly affected by the number of shares you purchase and current amount of the dividend.

This is in fact the definition of your cash flow. However, my experience, and I think yours too, would tell you that current cash flow is not a very good predictor of your success on a strategy that is dependent on this income. I'll leave the total return discussion for later. If you want a good experience where you don't end up with 100% REITS in your portfolio because they are the payers of the highest current cash flow, then you must use some other criteria - I will leave the choice of that up to you, but I would hope some of your metrics are related to the yield of the stock over time and not just the current yield.

Each investor has to decide how to design such a strategy, and it is my feeling that the more information you have (up to a point of course - information overload,) the better chance you have of improving your results over time. You may find that only a couple columns in a spreadsheet are like a picture that may take a thousand words to explain.

What you should also hope is that you choose a strategy that allows you to pick the right investments that work together in such a way that you have something similar to say a bond index fund (of sorts) where you can just buy and hold a series of diversified investments that generate your needed income. Not a strategy that turns you into a market timer always searching for the best current yield.

Though YOC may not be one of those metrics for you -- for me, and Warren Buffet, we will continue to use this metric to compare any investments where it may seem appropriate.

fd
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Re: Is yield on cost (YOC) a useful metric?

Post by FinancialDave » Sat Mar 22, 2014 1:00 pm

Riprap wrote:

I started this thread because YOC doesn't make a whole lot of sense to me, yet it is widely discussed among the dividend investing crowd. Although it seems to me that YOC involves some sort of cognitive bias (perhaps anchoring?), the possibility exists that my reasoning and thinking is flawed and that I'm failing to understand an important concept. Hence, my original post.

Is this a behavioral finance phenomenon?
I think if you use any one metric as your sole decision maker you could end up with a huge behavioral bias.

Here is the way Warren Buffet uses this metric in his own business:

http://www.nasdaq.com/article/yield-on- ... c-cm238208

Though some have indicated that YOC is just a metric for investors to "toot their horn," I suggest that maybe Warren is allowed to do this once in a while -- otherwise how else can your learn than from others who are (seemingly at least) doing better than you.

fd
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