Bond Yields and Distribution Rates
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One of the main attractions of a bond fund investment is the stream of income that it provides. When investors compare different bond investments, they tend to look at the income potential, or yield, of the fund. However, there are a few different methods of calculating and stating yield, which may make it difficult to compare those investments. Here are definitions of the most commonly used figures.
Current Yield
Current yield is quoted in many advertising and shareholder reports. It's a rather complex formula mandated by the Securities and Exchange Commission (SEC), which is why many people also refer to it as SEC yield.
Basically, the SEC "standardized" yield uses a fund's net income over the preceding 30 days to project an annualized yield – in theory, what you'd earn if you stayed in the fund for the next twelve months and it kept paying out at the same rate.1 Although that's not a very likely scenario,
SEC yield does give you a yardstick for comparing the results of different funds from different fund companies.
Monthly Distribution Rate
While the SEC yield's calculation is standardized, the formula for distribution rate – also called "distribution yield" – can vary. Most fund groups quote distribution rate as a monthly 30-day figure. Like SEC yield, a fund's 30-day distribution rate uses the previous month's income to project an annualized figure.
Even though SEC yield and 30-day distribution rate cover the same time period, it's not unusual for those two numbers to differ. One reason is the way they treat certain classes of securities. Preferred stock, bonds purchased at a discount or a premium, foreign bonds, and mortgage-backed securities are all handled differently by each calculation.
Annual Distribution Rate
Because of the potential discrepancies, many popular publications – Money Magazine and Morningstar, Inc.'s fund reviews, for example – prefer to use an annual distribution rate that represents the actual income paid out over the past twelve months.
Since they cover different time frames, the two methods usually produce different yields. For instance, in a falling interest-rate environment, a fund's 12-month distribution rate is likely to be higher than its 30-day rate, since the annual figure includes income earned during the prior months when rates were higher.
The annual distribution rate looks back at the actual payout, while the monthly distribution rate and the SEC yield try to predict the future.
1 The current or SEC yield for a money market fund is calculated using the fund's net income for the preceding 7-day period.
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