You may be investing in a fund that's simply doing the equivalent of moving money from one pocket to the other, either by investing in high-yielding securities that subsequently decline in value or by literally giving you your principal back, as I discussed in this article
. (Morningstar's closed-end fund team has also done a great job of shining a light on these practices, as in this article
But even if there's nothing nefarious going on at your investments, yield statistics can be misleading simply because they're so ephemeral. Just as past returns aren't a particularly good predictor of future performance, the yield you see today may not be a good measure of the payout you're actually apt to receive during the life of your investment.
Here Today, Gone Tomorrow
The key reason, of course, is that you arrive at a security's yield, in percentage terms, by dividing the security's income per share by its price per share. As that investment's price increases, it puts downward pressure on the investment's yield. On the flip side, a decrease in an investment's value leads to a bump-up in yield. As long as a security's price is moving around--and for some securities, this is happening every minute of every trading day--so is its yield.
The prevailing interest-rate environment also has a big impact on securities' yields, of course, and during the past few decades, the general trend has been down. In 2000, when interest rates were much higher than they are today, the typical short-term bond fund in Morningstar's database had a yield of nearly 6%; today it's about 2.2%. High-yield bond funds had yields of nearly 12%, on average, a decade ago; today it's just 7%-8%. That trend hasn't been all negative for bond investors, in that bond price increases have helped offset the decline in yields. But it's still a good reminder of how a bond fund's current interest rate doesn't foretell the amount of income you'll actually earn.
Finally, to the extent that you own dividend-paying stocks, it's worth noting that a company's dividend payout is discretionary and subject to change along with business conditions. Back in 2008, for example, financials stocks appeared to be a yield-seeker's paradise, with many boasting double-digit dividend yields. But those tempting payouts were, in many cases, symptomatic of deeply troubled businesses; as share prices ran down, yields skyrocketed. And with those declining market conditions, many banks dramatically reduced their dividends or suspended them altogether. Investors who flocked to financials then weren't just buying shares of troubled companies, they were also chasing illusory dividends.
What's a Well-Meaning Income Investor to Do?
All of those caveats don't necessarily mean you should ignore yields entirely when selecting investments. It does, however, suggest that you should take steps to make sure you're putting yield in the proper context.
For starters, hunt around for the most current yield statistic you can find. For individual stocks, Morningstar provides a projected yield statistic that factors in the fund's latest indicated dividend amount divided by the current share price.
For mutual funds, the yield statistic that appears on Morningstar.com is its payout percentage during the past 12 months. SEC yield, which is usually available on fund companies' websites, provides a more current snapshot, depicting the fund's income payout during the past 30 days (minus expenses) and annualizing that figure over a one-year period. Oftentimes the difference between a fund's trailing 12-month yield and SEC yield will be notable, illustrating the importance of hunting around for the more current number. For example, Vanguard High-Yield Corporate
has a trailing 12-month yield of 7.14%, but its SEC yield is 6.51%
And to the extent that you own dividend-paying stocks and their payouts are a big part of your thesis for holding them, spend as much time thinking about the safety of those dividends as the dividends themselves. Evaluating the sustainability of a firm's dividends is a big focus for my colleague Josh Peters in his DividendInvestor
Last but not least, remember that total return, not yield, is your real bottom line. Staying squarely focused on the former will help prevent you from diving into a high-yielding investment whose payout, in hindsight, was illusory.