How do you know how much income you are going to receive from a bond fund and how dependable that income stream will be?
Let’s start with the basics:
Do bond funds have to distribute all the interest income that they collect from the bonds they hold?
How often do bond funds distribute income to shareholders?
They are required to do so a minimum of once per year. However, most bond funds (4 out of the 5 largest) distribute interest income and short-term capital gains monthly. The exception to this rule is the Vanguard Inflation Protected Securities (VIPSX), which pays out quarterly. Typically, long-term capital gains are distributed once per year, at the end of the year.
The exact timing of when the money will come into your account is determined by the mutual fund or etf provider. However, as long as you are the owner of the fund at the end of the day on the “record-date”, you will receive the distribution on the “payable date”. Another term you will hear relating to this is “ex-dividend date”. Here are the definitions of each of these terms:
- Record-Date: The date the fund records who is an investor and is therefore due a payment. In order to receive an income and/or capital gains distribution you must be an owner of the fund on the Record-Date.
- Payable-Date: The date that distributions are made and the checks are sent.
- Ex-Dividend Date: The date in which the distribution is deducted from the share price of the fund.
Sometimes the dates are listed on the mutual fund company’s website, and sometimes you will need to contact the mutual fund provider in order to find out these dates.
A Bond Fund’s Advertised Yield
Most bond fund advertising focuses on the fund’s yield. The standardized yield number that all bond funds are required to report is the 30 Day SEC Yield. This measure is an estimate of the annual yield of a bond fund assuming the bonds in the fund’s portfolio over the past 30 days were held to maturity, and that all interest income is reinvested. (You can learn more about the SEC Yield as well as other measures of bond fund yield here).
Many investors will quite logically assume that the advertised yield of the fund is a good measure of the amount of income they can expect to receive from the fund in the future. Unfortunately this is not always the case.
Why is the Advertised Yield Not a Good Measure of Future Income Potential?
Because the Yield of a bond fund is constantly changing, for the following reasons:
- As interest rates rise and fall so does the value of the bonds the bond fund is holding in its portfolio. As the bonds in the portfolio change in value so will the bond fund’s yield. If the fund continues to hold the same bonds after interest rates change, then the fund’s advertised yield will change, but the dollar amount of the income payments will not.
- The majority of bond funds have a stated maturity range. For example, an intermediate bond fund will always hold bonds with an average time to maturity of between 4 and 10 years. In order to adhere to the fund’s stated objective, the fund will periodically sell bonds with shorter maturities and replace them with new bonds that have maturities which match the fund’s objective. The old bonds being sold and the new bonds being acquired will have different interest rates. When the fund sells bonds with one interest rate, and replaces them with bonds earning a different interest rate, both the fund’s yield and the dollar amount of your interest payments will change.
What should you focus on instead of yield?
If you’re living off the income, you want to know how much money you have coming in, and how dependable that income will be in the future. You can view the monthly dividend distributions per share on Morningstar.com for all the funds it covers, for the last 6 months. (You can see an example at the bottom of this page under the title “dividends and capital gains distributions”). Below is a table showing 4 of the largest bond mutual fund’s distributions for the last month (may 2012) along with the highest and lowest distribution for the last 6 months, which was taken from Morningstar.com.
Bond Mutual Fund and ETF Income Distribution Comparison
|Name Of Fund||May DistributionHigh/Low in Last 6 Months||Check You Would Receive For Owning 10,000 Shares (this would cost between $110K and $130K)|
|Pimco Total Return Fund (PTTAX)||May: $0.03177High/Low: $0.02461 / $0.09308||May: $317.70High/Low: $246.10 / $930.80|
|Vanguard Total Bond Market (VBMFX)||May: $0.02473High Low: $0.0246 / $0.0265||May: $247.30High/Low: $246.00 /$265.00|
|Templeton Global Bond (TPINX)||May: $0.05High/Low: $0.05 / $0.25||May: $500.00High/Low: $500.00 / $2,500.00|
|Vanguard Total Bond Market II
|May: $0.02211High/Low: $0.0217 / $0.2287||May: $221.10High/Low: $217.00 / $228.70|
Unfortunately looking at things from a cash distribution perspective is not without problems as well. As you will see from the table in two of the funds, there is a huge difference between the high and low distributions in the last 6 months. The reason why is that these funds had short term capital gains on bonds sold by the fund, which were paid out in the monthly distribution, along with the income generated by bonds held by the fund. Large variations in the monthly distribution numbers are almost always a result of a capital gains distribution made by the fund. As capital gains distributions will be much less consistent than income distributions, it is better to look at the months where the distribution is relatively consistent in order to get a feel for what distributions, and the income you can expect from them, may be going forward.
**As most funds distribute their long term capital gains in December, the month of december has the potential to show a large difference as a result of this once a year distribution.
How Stable Can You Expect These Numbers to Be In the Future?
As interest rates are at or near record lows, I think that it is safe to assume that the income distributions for most funds will not be moving down significantly (with the possible exception of funds that invest in non-investment grade bonds).
In general the shorter the average maturity of the bonds a fund holds, the more reactive the monthly dividend payment will be towards changes in interest rates. However, this is less applicable to actively traded funds that have high portfolio turnover, as they are swapping the bonds in their portfolio more regularly and receiving the current market rate as a result.
What’s the Bottom Line?
When trying to determine how much income you can expect from a bond fund, looking at the actual distributions made by the fund is a better representation of what you might expect than the advertised yield of the fund. However, as most bond funds do not hold bonds until maturity, it is not possible to know exactly how much income you will receive from a fund in the future, and exactly how consistent that income will be. The only way to know for sure how much income you will receive from a bond investment is to buy individual bonds which do not default, and hold them until maturity.Get our free guide to income investing here.