Yield on Cost (YOC): Why Your “50% Dividend Yield” is a Mathematical Illusion
Yield on Cost (YOC): Why Your “50% Dividend Yield” is a Mathematical Illusion
EXECUTIVE SUMMARY
- The Metric: Yield on Cost (YOC) measures your current dividend income relative to the price you paid 20 years ago. Investors love seeing a “50% yield” on their dashboard.
- The Trap: The market does not care what you paid. Your original cost basis is a “Sunk Cost.” The only thing that matters is the Current Yield relative to the Current Market Value (Liquidation Value).
- The Strategy: Ignore YOC. Evaluate every position based on its “Yield on Current Value.” If a stock pays 2% today but you could get 5% in a Treasury Bill, you should sell, regardless of your 50% YOC.
“I can’t sell Coca-Cola! I bought it in 1990 and my Yield on Cost is 40%!” This is the most common emotional error in dividend investing. While YOC is a nice “trophy” of past success, it is useless for making decisions today. It anchors you to the past. According to Team BMT Analysis, relying on YOC blinds investors to “Dead Money” risks. Capital allocation decisions must always be forward-looking. Source: Dividend Growth Investor / Investopedia
Scenario: You bought Stock A for $10. It is now worth $100. It pays a $2 dividend.
- The Illusion (YOC):
Dividend ($2) / Original Cost ($10) = 20% Yield.
Feeling: “Wow, I’m a genius. I can’t sell this cash cow.” - The Reality (Current Yield):
Dividend ($2) / Current Price ($100) = 2% Yield.
Comparison: A Risk-Free T-Bill pays 5% today. - Verdict: You are effectively keeping $100 in an asset paying 2% when you could have $100 in an asset paying 5%. Your “20% YOC” is costing you money.
Income Comparison: Holding vs. Switching
| Action | Annual Income (on $100k Value) |
|---|---|
| Keep Stock A (20% YOC, 2% Current) | 2000 |
| Sell & Buy T-Bills (5% Current) | 5000 |
*Chart Note: Despite the impressive “Yield on Cost,” switching capital to a higher current yield instantly increases your income by 150%.
CRITICAL SCENARIO: The “Capital Gains” Friction
When does it make sense to hold?
| Condition | Decision |
|---|---|
| Taxable Account (High Gains) | Hold (Maybe). Selling triggers massive tax bill ($20k+), reducing the capital available to reinvest. |
| Roth IRA / 401(k) (Tax-Free) | Sell Immediately. No tax friction. Move money to the highest bidder (best risk-adjusted yield). |
Execution Protocol
Go into your brokerage settings. Remove “Yield on Cost” from your dashboard. Replace it with “Current Yield” and “P/E Ratio.” Stop looking at the trophy.
Ask yourself: “If I had $100,000 cash today (the current value of your stock), would I buy this stock again at today’s price and 2% yield?” If the answer is No, you should sell it (tax permitting).
If you decide to sell, use Tax-Gain Harvesting (#355) or Donor Advised Funds (#411) to minimize the tax blow. Don’t let tax fear paralyze you in a bad investment.
WEALTH STRATEGY DIRECTIVE
- Do This: Judge your portfolio by “Total Return” and “Current Yield.” These are real numbers that affect your future net worth.
- Avoid This: Holding a “Legacy Stock” (e.g., AT&T, GE) just because your grandfather bought it and the YOC looks high. Companies die. Dividends get cut. Nostalgia is not an investment strategy.
Frequently Asked Questions
Is YOC ever useful?
It is useful psychologically. Seeing a high YOC validates that “Dividend Growth Investing” works over the long term. It encourages patience. Just don’t let it distort your sell discipline.
What about Dividend Aristocrats?
Aristocrats are great because they raise dividends, which increases YOC over time. But if an Aristocrat becomes severely overvalued (yield drops to 1%), it might be time to trim, regardless of YOC.
Does Warren Buffett use YOC?
He mentions it (e.g., “Our Coke dividend is 50% of cost”), but he holds Coke because it is a great business with a wide moat, not because of the YOC. He has sold other high-YOC stocks (like Washington Post) when the business logic changed.