# 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. This can certainly be done, although determining the yield is a little trickier than it may seem.

The yield quoted on the website of the investment management company offering the bond, which is usually the "distribution yield" or "TTM (trailing twelve months) 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

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 strictly on past performance with no projection of future performance, and as financial websites will remind you, past performance is not an indication of future returns.

### The Distribution Yield and Potential Inaccuracies

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 to calculate the distribution yield, using the following formula:

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

- Take the fund's distribution amount over the last month (usually the same thing as the current dividend)
- Multiply that by 12 to arrive at an approximation of the actual twelve-month distribution total
- Divide this hypothetical 12-month return by the fund's end-of-month net asset value (NAV)

This gives you the distribution yield or the same result as one of the distribution yield calculations often used by funds. This can give you an idea of the yield, but it's often a rough and inaccurate estimate of the annual return.

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

### Understanding Weaknesses in the Assumptions

The first and most obvious issue 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. At other times, however, the calculated income and the actual income may be quite different

The second assumption that compromises the distribution yield calculation's accuracy 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 at least a few percent higher than the same X yield spread over 30 days. This difference can skew your result a little further. The best thing one can say about this is that the difference won't be significantly material.

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

### Distribution Yield Calculation Fixes

Some obvious ways exist to make the distribution yield calculation come a little closer to reality.

- Don't assume an average monthly distribution; total the actual monthly distributions over the past year, then divide by twelve. That's the real 12-month trailing average.
- Adjust your "30-day distribution amount" to reflect an actual 30-day return—in other words, increase it appropriately in February and adjust it downward in 31-day months.
- 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 Securities and Exchange Commission (SEC) intervened in this 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 this figure to the Securities and Exchange Commission. Without getting into the details 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 reporters writing on the lack of clarity around 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 different distribution yield calculation variants 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.

### A Simple Remedy

One solution exists 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.