Some retirees own bond mutual funds for the convenience of professional management, liquidity, and diversification. But trying to figure out the bond income you’ll get from the bond fund to meet your living expenses, and how much estimated income tax to pay is not always a simple undertaking.
Your bond mutual fund might hold hundreds of different issues. And the manager could regularly sell the holdings and replace them with others. Consequently, as bonds move in and out of the portfolio, the yield could constantly change.
Here’s three methods of estimating your fund’s future bond income. Although the three methods described below can be useful guidance tools for estimating future income, you should never assume that your investment returns will be identical to the yield reflected by a particular method.
First, you could add up the bond fund’s last 12 month’s income and capital gains distributions. Then divide that amount by the most recent net asset value. This 12-month yield, however, might not be accurate especially if interest rates are rising, which might cause you to underestimate the fund’s current income.
Secondly, the Securities and Exchange Commission requires all mutual funds to use a consistent formula to calculate yields. The 30-day SEC yield, also known as the standardized or current yield, reflects the interest and capital gains earned per share over the prior month. The total, less expenses, is divided by the share price on the last day of that period. This is the number that fund companies frequently use in ads.
Even though the 30-day SEC yield will reflect interest rate increases better than the 12- month yield, the SEC yield still might not give us the complete picture in all cases. For example, suppose the fund manager made a change during the previous month that resulted in a distribution that was significantly higher or lower than normal?
For example, this could occur when a large number of bonds are sold at a profit or loss. Thus, the corresponding yield then might not give an accurate picture of what to expect in the future.
With this in mind, another method to estimate future income is to take a three-month snapshot of the fund’s distributions. You basically add up the per share distributions from the last three months and multiply that number by four. Then divide that number by the most recent share price. This could arguably give you a realistic yield picture since it includes recent interest rate changes and might also capture unusual distributions over a three month period.
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