Prospective investors are often confronted with lots of financial jargon, with some terms carrying similar names and confusing definitions. These investors must understand the difference between various types of investment return rates. These rates include the dividend rate, the annual percentage rate (APR) and the annual percentage yield (APY). While the dividend rate and the APY are ways to calculate an investor's rate of return, an APR is the rate of interest charged on a loan product.
A dividend rate is the rate an investor would expect to receive as a return on his investment; an APR, which stands for "annual percentage rate," is a rate of interest charged to borrowers paying back loans, including vehicle loans, credit cards and mortgages.
Dividend Rate Calculations
The dividend rate of an investment can be derived by multiplying the typical dividend payments by the number of dividend periods in a calendar year, plus any extra dividends. The dividend rate measures the amount of dividends an investor would receive on that stock during that year. A related calculation, the dividend yield, is the total amount of dividends divided by the stock price. The dividend yield shows how much of a stock's value is distributed to stockholders in dividends.
Dividend Rate Examples
If, for example, a stock valued at $42.50 per share delivers dividends of $1 per share each quarter, with a special $0.25 dividend per share at the end of the fiscal year. The dividend rate for the stock is (1 x 4) + 0.25, or $4.25. Broken down, the formula is (1 (dollars per share) x 4 (quarters in a year)) + 0.25 (the special dividend per share). The dividend yield can be calculated as the dividend rate divided by the stock price. In this example, the dividend yield is $4.25/$42.50, or 10 percent. Therefore, the dividend rate yields a 10 percent return to the investor.
Evaluating APR and APY
Bank customers will also encounter two similar terms: APR and APY. These terms, however, mean very different things.
APR stands for annual percentage rate. This interest rate reflects the rate that borrowers pay the bank on car loans, credit cards, mortgages and other credit instruments. If you borrow money from a bank, you have to pay back not only the amount you borrow, but also interest. The bank invested in you by loaning you money, and it receives a return on its investment when you pay the loan back with interest.
APY stands for annual percentage yield. This rate shows what investors can earn on bank-based financial instruments, such as savings accounts, certificates of deposit and money market accounts. Although APR and APY are tied to the prime lending rate, they are not typically the same rate.
APR and APY Examples
The APY determines the rate of return on interest-bearing accounts. For instance, an investor who puts $25,000 into a money market with an APY of 0.60 percent can expect an approximate annual return of (25,000 x 0.6)/100, or $150.
The APR is the rate of interest a borrower must pay on a loan. A borrower with a $24,000 car loan to be paid over 48 months at a 2.5 percent APR can expect to pay $500 in principal and $25.94 in interest each month. As such, an APR is not a return on an investment for the consumer, but for the bank, which is charging interest to offset the risk of lending you money.
Video of the Day
- Ridofranz/iStock/Getty Images