# Distribution Yield vs. SEC Yield: Which Should You Use?

## The SEC Bond Yield Calculation Offers a Standardized Means of Assessment

Investors contemplating the purchase of a bond mutual fund or bond exchange-traded fund (ETF) want to know what the yield may be on their purchase. Determining that is a little trickier than you may think. In fact, the yield quoted on the website of the investment management company offering the bond — which is usually the "distribution yield" or "TTM yield"  — may be substantially more or less than you'll receive if you buy and hold the fund.

In fact, there are several ways of determining yields: the distribution yield (and its variants) and the SEC yield. Which yield calculation should you use to find out what your actual return may be, and why does it matter?

### Looking Backward

Understand at the outset that neither the distribution yield nor the SEC yield can tell you what income your bond fund will produce from the time you buy it until you sell. Both yields are based on past performance. As you know and as financial websites will remind you, past performance is not an indication of future returns.

### The Distribution Yield and Why It's Probably Inaccurate

One aspect of distribution yield appraisal — your attempt to understand the significance of a bond fund's posted distribution yield — is that not every fund calculates it in quite the same way. Here's one relatively straightforward way:

The distribution yield is calculated by taking the fund's distribution amount over the last month — usually the same thing as the current dividend — and multiplying that by 12 to arrive what may or may not be the actual twelve-month distribution total.

It's a rough and often inaccurate approximation of the annual return. The calculation then divides this hypothetical 12-month return by the fund's end of month NAV, which gives you the distribution yield, or more accurately, one of the distribution yield calculations often used by funds:

Distribution Yield = 30-day distribution amount x 12/end of month NAV

This calculation incorporates three simplifications of the data that may compromise its accuracy or, worst case, its usefulness.

The first and most obvious is the seldom entirely accurate assumption that the income over the last 30 days multiplied by 12 equals the 12-month return. In some, perhaps many instances, it will come reasonably close to the actual 12-month return. And at other times, the calculated income and the actual income may be quite different

The second assumption that compromises the accuracy of the Distribution Yield Calculation is that not every month has the same number of days. If you calculate the return at the end of February, you're using a 28 day distribution period; if you calculate it in July, you're using a 31 day period. A fund that yields X dollars in 28 days has a return rate that is 30÷28 percent higher than the same X yield over 30 days. This difference can skew your result a little further. The best that can be said for this is that the difference won't be greatly significant.

The third assumption is that the current NAV represents the average NAV over the past twelve months. There's really no more reason to assume that this is accurate than to assume that today's stock price on Apple (AAPL) is its average over the past year.

In fact, in 2016, AAPL's share price has risen and fallen again over a nearly 40 percent range. Bond fund prices aren't often quite so volatile, but they're not immutable either.

### Some Distribution Yield Calculation Fixes

There are some obvious ways that the distribution yield calculation can come a little closer to reality. One is not to assume an average monthly distribution but to total the actual monthly distributions over the past year, then divide by twelve. That's the real 12-month trailing average.

Another is to adjust your "30-day distribution amount" to reflect an actual 30-day return — in other words, increasing it appropriately in February and adjusting it downward in 31-day months.

The third improvement is to average the trailing 12 months' daily NAVs.

The improved distribution yield calculation looks like this:

Distribution Yield = (Total of trailing 12-month distribution amounts) x (30/actual days in current month x 12) ÷ (total of trailing 12 months daily NAV/365)

When the distribution yield is calculated in this way, it's also called the TTM yield — TTM being an acronym for "trailing twelve months."

Toward the end of the 20th Century, the SEC intervened in this confusing situation and has since required all fund companies to post both their distribution yield, determined by whatever means they have historically used and the SEC yield, which requires using a standardized calculation prescribed by the SEC.

### What is the SEC Yield Calculation?

The SEC yield is so named because the yield companies are required to report to the Securities and Exchange Commission. Without getting into the weeds of the somewhat complicated actual calculation, which no investor is likely to make, the SEC yield figure approximates the yield an investor would receive in a year assuming that each bond in the portfolio is held until maturity. This measure also assumes reinvestment of all income and accounts for management fees and expenses.

Some analysts and financial writers, such as Karen Damato writing in a May 16th Wall Street Journal on the confusion in bond yield calculations, believe that the SEC calculation provides a more accurate result than the various distribution yield calculations and that it is more consistent on a month-to-month basis. In fact, whether one calculation will come closer to the following 12-month yield than another is to some extent a matter determined by the market. All yield calculations are reports on what has already happened, not what's to come. Further, while the variant distribution yield calculations make assumptions that may or may not represent reality, so does the SEC calculation: many actively managed fund companies almost never hold all bonds until their maturities.  However, the undeniable advantage of the SEC yield is that it is standardized — now investors can compare apples to apples.

One solution to the problem of which is better: Go directly to the website of either the mutual fund company or the company that issues the ETF. Since these issuers are required to provide both the distribution yield and the SEC 30-day yield, you will be able to gain a much better sense of the income you can receive from the fund. Morningstar Research, in fact, advocates taking both calculations into account — they argue that considering them both will give you a better feel for the performance of the fund than either one used alone.