Yield vs Interest Rate: What's the Difference?

Yield is the earnings from an investment over a specific period. It will include the interest earned and the dividends received from a particular holding. Yield is the annual profit that an investor receives for an investment.

The interest rate is the percentage charged by a lender for a loan.

For example, a lender might charge an interest rate of 10% for a one-year loan of $1,000. At the end of the year, the yield on the investment for the lender would be $100, or 10%. If the lender incurred any costs in making the loan, those costs would reduce the yield on the investment.

Yield refers to the return that an investor receives from an investment such as a stock or a bond. It is usually reported as an annual figure. In bonds, as in any investment in debt, the yield is comprised of payments of interest.

In stocks, the term yield does not refer to profit from the sale of shares. It indicates the return in dividends for those who hold the shares. Dividends are the investor's share of the company's quarterly profit.

For example, if PepsiCo (PEP) pays its shareholders a quarterly dividend of 50 cents and the stock price is $50, the annual dividend yield would be 4%.

If the stock price doubles to $100 and the dividend remains the same, then the yield is reduced to 2%.

In bonds, the yield is expressed as yield-to-maturity (YTM). The yield-to-maturity of a bond is the total return that the bond's holder can expect to receive by the time the bond matures. The yield is based on the interest rate that the bond issuer agrees to pay.

The interest rate on any loan is the percentage of the principle that a lender will charge annually until the loan is repaid. In consumer lending, it is typically expressed as the annual percentage rate (APR) of the loan.

As an example of interest rates, say you go into a bank to borrow $1,000 for one year to buy a new bicycle, and the bank quotes you a 10% interest rate on your loan. In addition to paying back the $1,000, you would pay another $100 in interest on the loan.

That example assumes the calculation using simple interest. If the interest is compounded, you will pay a little more over a year and a lot more over many years.

Current interest rates underpin the yield on all borrowing, from consumer loans to mortgages to bonds. They also determine how much an individual makes for saving money, whether in a simple savings account, a CD, or an investment-quality bond.

The current interest rate determines the yield that a bond will bear at the time it is issued. It also determines the yield a bank will demand when a consumer seeks a new car loan. The precise rates will vary, of course, depending on how much the bond issuer or the bank lender wants the business.

Interest rates constantly fluctuate, with the most important factor being the guidance of the Federal Reserve, which periodically issues a target range for a key interest rate. All other lending rates are essentially extrapolated from that key interest rate.

Ultimately, interest rates are reflected in the yield that an investor in debt can expect to earn.