You know that owning some bond investments is an important part of putting together your investment portfolio. Bond funds are a good way to go, but every fund lists its yield in two or three different ways, making comparisons difficult. A fund has a distribution yield, an SEC yield, and possibly an estimated annual yield. Each type of yield tells you something different about the expected return from the fund.
Bonds and Bond Funds
The yield returns from an individual bond are pretty straightforward. The current yield indicates the amount of interest you will receive based on the cost of the bond, and the yield-to-maturity is the annual return if you hold the bond until it pays off.
A bond mutual fund holds a portfolio of bonds, which makes figuring out yields more complicated. A fund does not have a fixed maturity, and the fund buys and sells bonds over time -- changing the characteristics of the portfolio. The dividends you earn come from the interest the fund earns, minus the fund's management expenses. Your bond fund investment results will adjust to changing bond market rates and prices.
Estimated Annual Yield
The estimated annual yield uses current interest rates and projected portfolio returns to provide a projected yield for the next year. Think of the estimated yield as a marketing projection -- not really a number to be seriously considered. The yield estimate is based on the past yield history and is not guaranteed to be the actual return you would earn. If a fund provides an estimated annual yield, that number should not play much of a role in your investment decision. More typically, a bond fund provides a current distribution yield and the SEC yield.
Pay attention to the 30-day SEC yield of a mutual fund. The federal Securities and Exchange Commission developed the yield formula to provide a common basis for comparing different funds. The SEC yield uses the current earnings from a fund's bond portfolio minus the fund's management expenses. The resulting SEC yield is similar to the yield to maturity for an individual bond -- the type of serious number on which to base your investment decisions. Investment experts recommend using the SEC yield to determine the expected return of a fund and to compare the yields of different bond funds, according to a Feb. 1, 2010 article in The Wall Street Journal.
The distribution yield is the return that you tell your friends your bond fund pays. The yield is the current dividend rate divided by the fund share price. A bond fund pays a dividend every month, and the standard distribution yield uses the latest 12 months of dividends divided by the share price. A 30-day distribution yield calculates the yield using just the most recent dividend amount.
Do not confuse the 30-day yield with the 30-day SEC yield. Some funds list both. Think of the distribution yield as the amount of money the fund would put in your pocket if you took the dividends in cash -- assuming the current dividend rate continues into the future.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.