Look out! Investment yield vs. investment distributions
June 23, 2014 by Editor, InvestingForMe
We’ve just finished updating our exchange-traded fund (ETF) catalogue and just had to comment on a growing trend in the fund industry that we believe is hurting investors – from both an investment and retirement income perspective.
Specifically, it’s the trend by more and more funds in using an investment’s distribution yield as synonymous for an investment’s yield. And what a difference one simple word can make to your pocket book!
By making distribution yield synonymous for investment yield, fund companies are making it harder for investors to invest and plan for their future retirement because when you buy an investment believing that its distribution yield equals its investment yield, you could end up spending your own savings rather than the actual income earned by the investment. And some fund companies have even taken this confusion to a whole new level by inventing and using a completely new term – Distribution Yield!
Has this happened to you?
Imagine a common scenario where you agree to give a fund company $10,000 to invest because you’re told that they’re going to pay you 6% (or $600) each year and then return your money after 5 years. Often, however, 5 years down the road, you only have $9,000 of your original $10,000 in savings actually invested. Now, that sounds so wrong, doesn’t it? Sounds like the fund company was dishonest.
Actually they weren’t. They simply confused you by letting you mistakenly believe that the investment would only be paying you the investment income earned. They forgot to tell you that $200 of that $600 payment was actually a return of your own savings – they paid you $200, per year, of the original $10,000 that you invested with them. So while you mistakenly thought the $600 represented the income earned by your $10,000, in fact only $400 came from your earnings and $200 was a deceptive repayment of your own savings. So you no longer have $10,000 invested, but rather only $9,000 remains because the fund, over the past 5 years, has paid $1,000 (5 X $200) back. And this happens all the time!
Note: When an investment makes a distribution payment and that payment includes a portion of your original savings, your savings portion is called a Return of Capital (ROC). If you own mutual funds or ETFs, you’ll need to review the funds annual income tax information to determine how much of your own savings are being paid back to you.
In the fund companies’ defense, they usually never actually say the $600 payments are going to be only the income earned on your $10,000. You simply assume that the 6% is your actual investment yield, when in fact the fund company said it would be your distribution yield. In fact, we as average investors often mistakenly assume the 6% was our investment’s yield when really it was a distribution yield. And this “misunderstanding” happens all the time to Canadian investors with thousands of investment funds (including segregated funds, mutual funds, ETFs, etc.). So how can you avoid this pitfall?
The term “distribution” can be deceptive
In the investing world, the word distributions is a kind of catch-all term that can include any or all of the following dollar amounts that are used to describe an investment’s makeup and can be found on the investment’s Fund Fact Summary:
- dividends earned
- interest earned
- other income earned
- capital gains
- foreign income, and
- a return of capital (ROC)
And in fact, the item that makes distribution yield so different from investment yield is the last item on the list – return of capital (ROC). This is the culprit that causes all of the confusion and misery for investors. Simply put, when a fund pays you a return of capital, they’re paying you back your own savings.
So, how is this deceptive? Well, when the fund states that its yield equals 5.0%, investors often assume this 5.0% represents the investment’s earnings and they don’t dig any further. So when it comes time to invest their hard earned savings they will compare the different investments assuming that each investment uses the same definition for yield – when they don’t!
For example, let’s take a look at the distribution and investment yields for a couple of Canadian Dividend Exchange-Traded Funds (ETFs) in the following table:
|Distribution Yield (2013)||Actual Investment Yield (2013)|
|BMO Canadian Dividend ETF||5.15%||4.53%|
|First Asset Morningstar Canada Dividend Target 30 ETF||3.56%||2.19%|
|iShare Dow Jones Canada Select Dividend Index ETF||5.05%||4.82%|
|Powershares Canadian Dividend ETF||4.25%||3.82%|
|Vanguard FTSE Canadian High Yield ETF||3.11%||3.11%|
Note: Some mutual funds and ETFs, like Vanguard’s Dividend ETF, don’t pay investors with their own savings. They pay you the income actually earned!
The above is just a small sample to demonstrate how investors are deceiving themselves when they compare investments using the distribution yields. And this deception is even worse if you’re retired and depend on your investment income and, because of this mix-up, you just might be spending more than you’re making and unknowingly living beyond your means.
So, we’ve tried to make you aware of this little word game problem clouding our current investment arena, and hope you’ll grow more knowledgeable in an effort to save your hard earned investments.
Next week, we’ll show you how to get the correct numbers in order to make the best investment by finding a fund’s investment yield instead of its distribution yield. Knowing an investment’s proper investment yield) will help you to make
- better investment decisions by making an apples-to-apples comparison between investment options, and
- sure you’re only spending your investment earnings and not your hard-earned savings.
To read more, click - Distribution yield: getting blood from a stone