This being the season for Individual Retirement Accounts, every investment business in town is hoping to get its hands into your wallet. To earn that right, they're competing to offer fat, double-digit yields, dazzling the saver who yearns to be both safe and rich.
The trouble is, you can't be both. But you could easily imagine such a thing to be possible from some of the IRA advertising -- especially for bond mutual funds. Their well-publicized yields, while not technically untrue, can easily exaggerate their current performance. As a result, investors may think that they are earning more than is actually the case.
The Securities and Exchange Commission has been pressing the mutual-fund industry to wipe the hyperbole out of its ads and prospectuses. It is particularly troubled by ads that make risky funds look safe or mislead investors about the yield they're likely to get.
The Investment Company Institute has proposed to the SEC a standard way of calculating yield so that buyers could readily compare one income mutual fund with another. Among other things, it would force bond funds to use a standard calculation for bonds bought over face value -- which may sound small, but in fact would be a huge and welcome change. Right now, the yield on such bonds can be reported in a way that vastly overstates the real return you're likely to get.
Unfortunately, new regulations won't be passed in time to help you through your IRA decision this year. For your guidance, here are some of the claims that most bother the SEC:
*Ginnie Mae mutual funds and unit trusts. The ads may say "Government Guaranteed" in big black type, followed prominently by a big fat interest rate. The overwhelming impression is that both your investment and the advertised yield are backed by the U.S. government.
Wrong. Ginnie Maes are pools of mortgages whose principal and interest payments are guaranteed by the U.S. government -- which means that the feds will cover any mortgage payments that go into default. But the government does not guarantee the all-important market value of your Ginnie Mae fund or trust, which will rise and fall with market conditions. Nor does it guarantee that you'll get all of your principal back when you sell.
The SEC wants Ginnie Mae mutual-fund ads to give equal weight to all the risks. That might mean bigger type for such phrases as "yields will fluctuate."
With single Ginnie Mae pools, the government doesn't even guarantee that you'll get the advertised yield if you buy an older security that has been on the market for a while. In many such pools, the stated yield assumes that all the mortgages will be repaid over 12 years. If you pay a premium for the Ginnie Mae and large numbers of mortgage borrowers repay their loans ahead of time (as is happening in today's refinancing boom), your yield could be much lower than you expected.
Unfortunately, some of the biggest offenders are small brokerage houses that advertise Ginnie Mae pools at exaggerated, estimated yields. None of the proposed mutual-fund regulations would affect this unhappy practice.
*Bond funds. They advertise various high yields, mostly in the double digits. But investors don't realize that each fund might have calculated its yield in a different way. Two funds earning exactly the same amount of money can give two different yields depending on how they do the math. As a result, you cannot truly compare funds' yields. The SEC wants a standardized yield calculation, used by all funds, so you can accurately compare performance. Until then, be aware that a half-point difference in yield may be more apparent than real.
*Old yields. Some bond funds advertise their average yields for the past year. Because interest rates have been falling, those yields will be much higher than any investor could expect today.
Your best proxy for what the fund currently earns: a seven-day yield, calculated as of the day before the ad appeared. Be aware that magazine ads are more likely to be out of date than newspaper ads.
*Stock-owning mutual finds. Here, too, recent yields can be wildly exaggerated. A fund that advertises 30 percent returns during the past 10 years may have done sensationally well from 1975 to 1978, but shown mediocre performance ever since.
The SEC thinks that funds should advertise only their most recent year's performance. Long-term performance is an important consideration for investors. But recent returns will tell you whether management is still on the ball.