Understanding income returns

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September 10, 2012
Income returnsUnderstanding income return is definitely one very difficult concept especially for upcoming entrepreneurs. This is however a very important aspect in running a business. Therefore we decided it was better if we addressed this concept.We therefore have to address the process entirely right from understanding an income retuns to evaluating it against other types of returns. Income return is for example you bought shares worth KSh. 50,000 and sell them later at KSh. 75,000; your return is KSh. 25,000. You therefore will have made a 25,000 shillings return as you have sold your shares and pocketed the profit. Income return is therefore the money you make over the cost of your investment.

The other way of earning a return is if for example you invest in shares and it generates income, maybe quarterly or monthly. Or let’s say you bought a house worth KSh1 million and each month you receive KSh 20,000 in rent. You see, you haven’t sold the house but are earning from it. Your return per year in this case is therefore Ksh 200,000 or 20 percent.

This kind of return is also referred to as yield and answers the question – What guaranteed cash return will I get if I invest this money? However, when waiting to sell, the return is not guaranteed until the day when it is sold but with a steady flow of income, it is. YIELD therefore has nothing to do with whether the value goes up or down, but with the actual money flowing in.

The concept of YIELD is used in various investments driven by income and especially rental property, bonds and even companies in form of dividends. The stock market page will have a column titled Dividend Yield because it simply expresses your actual cash return (via a bonus) if you buy the share at a given price. The company will pay that dividend irrespective of whether the share price goes up or down.

If you are investing with the key objective being income, you will use the YIELD as a comparison between two or more investment options. Considering our example on the house, say you got a different opportunity to buy property worth KSh 2.5 Million and it will give you rent of KSh 15,000 per month (KSh 180,000 per year). You may think to yourself that’s more money. However the yield here is 7 percent (KSh 180,000/KSh2.5 M) compared to the 10 percent yield in the first property.

Capital gains have their place as well but at some point, you will need your investments to generate some income. The YIELD may become far more important to you than the growth in value of the asset because this is the income that will be sustaining you.

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To ensure you get the best opportunity for your money, always evaluate different assets using this YIELD especially if your objective is driven by the need to have passive earnings as opposed to growth in value.

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