When investing in individual bonds the most accurate representation of the income you will receive is the Yield to Maturity. A bond’s yield to maturity takes into account the bond’s coupon interest payments, the difference between the purchase price of the bond and its face value, and the return you should receive from reinvesting the coupon payments. It also assumes that you will be holding the bond to maturity.

Most bond funds do not have a specific calendar date when all the bonds in the fund’s portfolio mature. They are constantly buying and selling bonds in order to maintain a specific average maturity, as required by the fund’s objective. Because the bonds in the fund are constantly changing, the yield you can expect to receive will fluctuate as interest rates change. While there is no way to know exactly what the income stream will be, there are several types of yield calculations that are meant to give investors an idea. Here are three of the most popular:

### Distribution Yield

The distribution yield is comparable to the current yield for an individual bond. It is the dividend income distributions made by the fund in the last 30 days divided by the Net Asset Value of the fund, which is then annualized. The advantages of the distribution yield are that it is a relatively simple calculation which uses the most recent income distributions in its calculation. However, there are three important disadvantages of distribution yield:

- The Distribution yield is taking into account historical returns for the last 30 days only, which may differ significantly from future returns.
- The Distribution yield does not take into account the fall in value of bonds which trade at a premium to their face value as they move towards maturity, or the rise in value of bonds which trade at a discount. (for an explanation of premium vs. discount bonds go here)
- The Distribution yield does not include the returns that would have been gained through the reinvestment of monthly dividends.

You can see the formula for calculating discount yield here.

### 12 Month Yield

12 Month yield is very similar to the distribution yield, except that it looks at distributions made over the last 12 months versus the most recent distribution. A bond fund’s 12 month yield takes all the interest payments made by the fund over the last 12 months, and divides it by the fund’s NAV at the close of the past month + any capital gains distributions that were made during that same time period. In addition to being a simple formula, the advantage of the 12 month yield is that it gives you an accurate measure of the average income paid by the fund over the last 12 months. The disadvantage is that interest rates are unlikely to be the same in the future as they were over the previous 12 months. In fact, if interest rates have moved during the last 12 months, there may even be a significant difference between the 12 month yield and the distribution yield. Of all the popular measures of yields, 12 month yield may have the least predictive power.

You can see the formula for calculating 12 Month Yield here.

### SEC Yield

SEC Yield is different than distribution yield in two ways. It includes more than just the coupon payments. It also includes changes in the bonds value based on getting closer to maturity. (Essentially its assumes that the bonds will be held to maturity) Secondarily, it takes into account the compounding (reinvestment) of distributions. The SEC Yield is is the closest comparison to the Yield to Maturity of individual bonds.

All bond mutual funds and bond ETFs are required to report SEC yield and make the calculation using the same exact same formula. This allows you to make an “apples to apples” comparison. For these reasons this is the prefered method used by Learn Bonds when looking at the potential for income a bond fund has in the future.

Keep in mind however that as most of the bonds in a bond fund are not held until maturity, actual return received in the future may differ substantially from the SEC Yield.

You can see the formula for calculating the SEC Yield here.

### Expenses & Capital Gains In Yield Calculations

All measures of yield (distribution, 12-month, SEC Yield) are post the fund expenses. The yields would be higher if expenses were not deducted. Long term capital gains distributions are not included in income distributions but short term capital gains are.

This lesson is part of our Free Guide to the Basics of Investing in Bond Funds. Continue to the next lesson here.

**Want to learn how to generate more income from your portfolio so you can live better? Get our free guide to income investing here.**

**To see a list of high yielding CDs go here.**

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