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Deciphering Yield: Let Me Count the Ways

The definition of yield is simple, but there are many ways that it can be calculated.

Helen Modly and Tommie Monez, 07/13/2012

Clients are asking a lot of questions about yield these days. Why is it so low? How much can I earn on my "safe money"? How much are my stocks and funds paying in dividends?

When a client asks for the yield on a particular investment, what is the answer? When you are comparing funds, are you using common measurements? Do you ever wonder why the yield on a fund is radically different from the last time you checked? Do your clients wonder why the yield they see quoted isn't the same yield that they experience?

Dividend-paying companies are not necessarily inherently better than companies that reinvest their profits. In fact, there may be more upside potential for companies that are plowing the earnings back into research or expansion. However, there is no getting around clients' recent interest in dividend-paying stocks and funds as a reaction to market volatility and concerns about the future.

Although our firm takes a total return approach to investing, we also collect yield data on the funds that we use. This allows us to reassure clients who are concerned about the cash that their portfolios are throwing off. It also helps us keep track of interest and dividend income, which will allow us to reposition portfolios as necessary when tax laws change. In 2013, the 3.8% Medicare tax will take effect for clients with adjusted gross incomes of $200,000 for individuals and $250,000 for joint filers, and we want to be ready. In addition, dividends may be subject to a higher tax rate when the current tax laws expire.

We use mutual funds and exchange-traded funds for our equity positions, and until bond ladders start to make sense again, we also use mutual funds and ETFs for fixed income. It's simple enough to calculate the yield on a single bond or for a single company, but a fund may have thousands of holdings with widely fluctuating distributions. There are various ways to measure yield, and mutual funds and ETFs can have yields that vary considerably, depending on the method of calculation.

Simply put, yield is the return on an investor's capital investment. It is the percentage rate of return paid in dividends for stock or the amount of interest paid for a bond. The definition is simple, but there are many ways that it can be calculated. It's important to use the same form of measurement when comparing funds and choosing the right investments for a portfolio. There are several types of yield calculations:

SEC Yield
This method was created and mandated by the Securities and Exchange Commission in order to provide a standardized means of comparison. It is based on the current market yield to maturity for bonds or projected dividend yield for stocks held by a fund over a trailing 30-day period, less the fund's expenses, annualized. This is also referred to as the "standardized yield." The SEC yield for money market funds is calculated by annualizing the daily income for the past seven days. It may be an accurate representation for the short term but can vary widely from a fund's actual experience.

Average Yield to Maturity
Yield to maturity is the rate of return expected if a bond is held to its maturity date. The average yield to maturity approach aggregates the yield statistics for all of the holdings of a bond fund. This method provides another standardized approach for comparing funds; however, it does not take into account fees and expenses, so the investor's actual experience will never match the stated yield.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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