Distribution Yield vs. SEC Yield: Which Is More Useful?

A reader writes in, asking:

“When I look at a bond fund on Vanguard’s website, it provides an ‘SEC Yield’ and ‘Distribution yield.’ What’s the difference between these and which should I be paying attention to?”

A bond fund’s distribution yield is basically the distributions paid over a recent period, annualized, divided by the net asset value of the fund.

Upon initial consideration, that sounds like something that would be helpful to know. It sounds like it would provide a decent estimate of what level of income to expect from the fund.

But it doesn’t. For a few reasons, distribution yield is a nearly meaningless figure — at least from the perspective of the individual investor trying to figure out what to expect from the fund. Specifically:

• Distribution yield is not especially useful for comparisons between fund companies, because different fund companies do the calculation differently. Vanguard, for instance, looks at the most recent monthly distributions and annualizes that figure, while Fidelity looks at the last 12 months of distributions.
• Because distribution yield is backward-looking (sometimes up to 12 months), it can be influenced by an interest rate environment that could be quite different from today’s.
• Distribution yield is focused entirely on distributions (i.e., cash flow), so it doesn’t properly account for amortization of bond premiums or discounts (i.e., non-cash flow factors that affect the actual rate of return earned).
• Distribution yields can include returns of capital (i.e., distributions that were not really income).

In contrast, SEC yield is much more useful.

• The calculation of SEC yield is standardized, which means you can compare from one fund company to another.
• SEC yield does a better job as a forward-looking indicator. (As Vanguard describes it, SEC yield approximates the after-expenses yield an investor would receive in a year, assuming that bonds in the portfolio are held to maturity and all income is reinvested.*)
• SEC yield focuses on actual income earned rather than cash flow.

*If you want all the nitty-gritty details of the calculation, you can find them beginning on page 35 here under the heading “Yield Quotation.”