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Distribution yield: getting blood from a stone

July 3, 2014 by Editor, InvestingForMe

For years now investment companies have been caught in a tightening vice – interest rates and investment yields continuing to fall at a time when greater numbers of investors are retiring and demanding higher income from their investments. The investment funds have merely given investors what they’ve demanded – higher regular payments from their investments by paying out the investment’s earnings plus a portion of the investor’s own savings (return of capital). And we investors come away believing we’re satiated and happy.

Note: This article continues from our previous - Look out! Investment yield vs. investment distributions

 

After all, our financial plans need a certain investment return for them to work and to support our desired retirement lifestyles. So we happily believe our investments are earning and paying us 6% every year. But somebody ought to start asking the investment pros how they’re able to achieve the impossible – how they manage to get blood from the stone. Fortunately for the pros, sometimes ignorance on the part of us average investors is bliss!

But eventually the truth will come out, and some of us might not be so happy with the results when that $10,000 we want to re-invest only comes back as $9,000. And while some well-to-do investors might have lots of spare cash and be OK with losing some investments due to little “misunderstandings,” most of us, however, don’t have that luxury. We’ve got our hard-earned limited savings and can’t afford to have any of it disappear. And so we want our spending to be based on the actual earnings from our investments – as it should be! – which is called earnings from an investment’s yield.

An investment’s yield: definition

What’s an investment’s yield? Well, it’s exactly what you probably think it is. It’s the money your savings actually earn each year.

Let’s look at a rather straightforward example. Let’s say that you invested $10,000 in a Guaranteed Investment Certificate (GIC) that agrees to pay you 4% (or $400.00) per year. As you know, GICs earn and pay you a set amount each and every year and when the GIC matures, you’ll get your all of your $10,000 back. So, in this example, your investment yield (4%) is calculated by dividing the income earned ($400.00) by the amount you invested ($10,000).

So, it’s pretty simple. An investment’s yield is simply the rate of return earned by your invested savings. It’s the money you can safely spend and still have all of your savings left at the end of the day! And you want to identify an investment’s yield (and not its distribution yield!) in order to decide if it’s a good investment for you.

Where to find it

To make sure you’re not spending your savings from an investment, rather than your earnings from an investment i.e. you’re not mistaking a fund’s investment’s distribution yield for its investment yield, you’ll need to do some digging. Unfortunately there are no simple listings on a Fund Fact Summary sheet that neatly identify each! So, don’t simply assume that the fund’s stated yield is the investment’s actual yield. You’ll need to get close-up and personal with the Fund’s Facts to find out how much of those regular fund distributions is actually a return of capital – or in other words, a return on your own money! And you don’t want that!

So, here are a couple of ways to help you determine an investment’s yield from its Distributions info. You can either

  • visit a fund’s website and click on the tab labeled Distributions. Then look at the previous year’s distribution taxation information. The fund company will give you a breakdown of the types of income it earned including how much of the fund’s distributions was actually a return of capital – how much of the money you gave them was paid back to you in the year. For example, take a look at the 2013 distributions for the BMO Canadian Dividend ETF (ZDV). At the bottom of the page, you’ll see that of the $0.83 paid to investors in 2013, $0.11 or 13.25% of the distributions was actually a return of investors’ own savings. or
  • visit our ETF catalogue if you’re investing in ETFs, select an ETF by name, click on its trading symbol and then its description, then scroll down to the Distributions information where we conveniently tell you the investment’s yield.

So, while finding an investment’s yield may take an extra minute or two on your part, you won’t have any surprises at the end of the day. You’ll feel better knowing that

    • your decision to buy a fund will be based upon accurate and comparable information.
    • you’ll know exactly how much your savings are actually earning for you, and
    • you’re only spending your investment earnings and not your hard-earned savings.

 

 

 

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