When comparing a forward-looking yield (Annual Percentage Yield, APY) with the historical total return of an investment, it’s important to understand the key differences and considerations.
Key Differences #
- Time Period
- APY: Represents the interest earned over a full year.
- Historical Total Return: Reflects the performance of an investment over a specific period.
- Risk Levels
- Cash Accounts: Typically have a guaranteed return and are FDIC insured.
- Investments: Include varying levels of risk, and returns can be more variable.
Calculation Breakdown #
To compare the APY with a partial-year return, such as 97 days, we need to adjust the APY to cover the same time period. Here’s an example of how to do it:
This calculation helps us understand how the APY compares to the historical return over the same period.
Important Considerations #
- Risk Comparison: Cash accounts are FDIC insured and offer predictable returns. Investments are subject to market fluctuations and may not be insured, resulting in variable returns.
- Expected Return: While cash accounts provide a relatively straight, upward slope in growth, diversified investments (consisting of stocks and bonds) are likely to outperform bank deposit products over a full economic cycle due to their higher yield potential.
For example, an investment portfolio with diversified exposure to stocks and bonds might have an expected yield of 5.81% over the coming year, which combines with price changes to produce the total return.
Liquidity #
Having a portion of the investment in investment-grade bonds in a portfolio can ensure liquidity so that cash is available on short notice if needed. We generally work with clients to ensure their strategies incorporate such needs, but things change. You should reach out to your Ethical Capital representative If you feel it would be beneficial for your accounts to have liquidity at the ready for such situations.
