All those `yield' signs should read `caution' for wary investors
Here's the latest favorite word from the financial hucksters: yield. Banks tout high-yield certificates of deposit; insurance companies push annuities with claims of long-term yield; and the latest buzzword in the mutual fund business is ``enhanced'' yield, used to describe a type of fund that is quickly getting the discrediting it deserves. All of these businesses are figuring that most people don't know the difference between yield and total return, and won't bother to find out.Skip to next paragraph
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``The word is definitely being abused,'' says Laura J. Berger, executive director of the No-Load Mutual Fund Association. ``People see a yield figure and think they are going to get that return.''
In some cases, the total return may actually be more than the advertised figure. But in many others, it can be less - far less. Infrequent compounding of interest, sales commissions, early-redemption fees, management charges, and marketing expenses can all erode the expected yield.
``I've seen insurance products that promote an 8 percent yield,'' says Robert Underwood, a financial planner in Birmingham, Ala. ``But after the fees and charges are taken out, the actual return is 4.2 percent.''
Yield is supposed to be defined as the return on investment. But the word has been so misused and abused in recent years that ``total return'' has become the more meaningful term. Nowadays, yield seems to mean the current interest rate, as stated by whoever is paying it: A bank may advertise a 6.75 percent interest rate on one-year certificates of deposit, but after compounding, the effective yield, or total return, is 6.9 percent.
In the mutual fund business, Ms. Berger says, yield is the annual income before any gain or loss in the price per share, while total return includes both yield and changes in price per share calculated over the investment period. So while a mutual fund may advertise a ``current yield'' of 7.4 percent on a tax-free bond fund, if bond prices drop your principal will erode, and your total return at the end of a year could end up far lower than 7.4 percent. A negative total return, in fact, would leave you with a loss.
Investors in bond funds, especially municipal bond funds, got a painful lesson in this rule last spring. In a few weeks in April, bond prices dropped dramatically, and many long-term muni-bond funds lost 6 percent or more of their value. Still, the ads and promotional literature were talking about the high tax-free yields while paying little or no attention to share price and how that would affect the total return.
Changes in insurance policy yields aren't so dramatic, but the difference between the yield the insurance agent talks about when you're considering a universal life policy or an annuity and the total return can also be surprising.
``Fees and commissions tend to cut into your return a great deal,'' says Christopher Croft, a financial planner in Palo Alto, Calif. ``You can give up at least 8 percent on commissions in the first year.'' Other costs that can affect how much money you really get include the cost of the death benefit, early-redemption fees, marketing and advertising costs, and administration.