What Society Tells Us about Yields
One concept that I hear a lot among investors and non-investors alike is the belief that they cannot set their own yield (aka return on investment). Rather, society has accustomed us to believe that the yield is set by banks, corporations or the government (e.g., CDs at 2%, dividend stocks at 4%, government bonds at 2.5%, etc.), and we simply have to take what is offered to us.
However, that is not true. As investors, we can determine our own yields, but we have to go where no one else is fishing (and know how to use a financial calculator).
How to Get a Higher Yield
So, in today’s Calculator Challenge, I will show you how this works. Let’s assume that our friend Holden is tired of investing in treasury bonds so he decides to go into buying seller financed mortgaged notes. (if some of you are wondering what these notes look like, check out this blog where I discussed creating one to be sold to an investor)
Holden finds a note, secured by good collateral. The note that has a face value of $20,000, has an interest rate of 6%, is fully amortized over 5 years, and has monthly payments of $386.66. The note was just created and no payments have been made (note: for simplicity sake, we are not going to discuss “seasoning” which means how solid is the track record of payments on the note and can have an effect on the value of the note.).
Holden, however, does not want to get an interest rate of 6%. Here is where most people get tripped up. They assume that because the note has a face value interest rate of 6%, that the best yield that they can get is 6%, but this is NOT TRUE!!!!
Holden knows that by changing the purchase price he changes his yield (think of a see-saw, one number goes up (the yield) another number must go down (price Holden pays). Holden wants to get a yield of 14% on his money. So, what price would Holden have to pay to get that interest rate?
Answer (these are the buttons to push into your HP 10bii financial calculator)
N (number of months) = 60 (it is a 5 year/60 months note)
I/YR (interest rate/years) = 14 (this is Holden’s desired yield. He does not care what the face value of the note says, he determines his own yield)
PV (present value) = ??? (this is what we are solving. Holden is working to determine how much he will pay for this note today to get 14%)
PMT (monthly payments) = $386.66 (these are the monthly payments that the note produces)
FV (future value) = 0 (it is fully amortizing, so after 60 months, there are no more payments)
After entering these numbers, the result is $16,617.49. Meaning that for Holden to get his money working at 14%, he must buy the note for $16,617.49.
I hope that this helps to clarify a little of your understanding on yield and return on investment. If you have any further questions, feel free to leave a comment below.
ps - If you want to learn more about how to purchase notes, structure deals with the financial calculator, and much more, I am going to be one of the speakers at the seminar, “The Millionaire Makers - The Next Generation” on May 19-21 in Palm Springs, CA. To learn more, visit: http://millionairemakersnextgen.com/ . Sign up before Feb. 1 for special early bird pricing. If you have any questions, feel free to send me an email.