Yield to Maturity or Yield to Returns refers to the rate of return expected out of a bond, if it is held until its date of maturity. In short, it is a long-term bond yield expressed in terms of its annual rate. It is calculated after taking into account the current market price, its par value, time taken to mature and its coupon interest rate, based on the assumption that all coupons are reinvested at the same standard rate. It helps investors comprehend the possible expected returns out of a fund.
In order to calculate the approximate Yield to Maturity (YTM), a bond yield table is used. However, this method is considered to be complex in nature, since it involves a time-consuming trial and error method. Thus, a simplified programmable business calculator is used for this purpose.
Average portfolio maturity is the main reason behind the under performing benchmarks behind over 25 long-bond funds. As compared to Fixed Deposits, short-term funds are believed to give better returns, as believed by many market analysts. However, with a constant fluctuation in interest rates, the troubling question disturbing all investors is how to safeguard profits when interest rates start to crumble?
Many market analysts and wealth managers advise investors that in such a scenario, long duration debt funds can be your best and safest bet. If you are planning to invest in a debt mutual fund, you must bear two factors in your mind – the Average Maturity and the Yield to Maturity of your respective portfolio. Most fund fact sheets and aggregates invariably, provide information on these two components to investors.
A debt mutual fund refers to a marketable commodity that can be invested in various fixed-income instruments such as Government bonds and securities, certificates of deposits, and other corporate papers. It is important to note that every instrument has its own maturity date, that is, the date on which its holder is paid back the original amount of money borrowed. Thus, average maturity refers to the average of all the maturities of the debt instruments held in a common fund portfolio. It is used as a tool that helps investors understand how sensitive a bond fund may be towards fluctuating interest rates. Its mechanism is quite lucid and simple. When interest rates fall, the price of the bond rises. As a result, investors enjoy capital appreciation which in turn boosts returns on their debt fund portfolios. On the contrary, when interest rates rise, the price of the bond falls. Thus, the value of the fund goes down simultaneously, leading to a loss for its investors. Hence, investors need to understand that if the portfolio of a debt fund is filled with long-term bonds with a high average maturity, they will be extremely sensitive to fluctuations in interest rates.
If the interest rates are expected to fall in the near future, the profitability on funds may rise. It is thus advisable for the investors in long-term bond funds to push the average maturity of their fund to the higher end, so as to enable long-term rates to fall. Try not to act on impulses and withdraw your funds frantically on the slightest downward movement of your fund. It is not really necessary since, such downfalls are only for a short period and such fluctuations are bound to be corrected over a period of time. You obviously do not want to opt for loans like home loan etc to fulfill your requirements just so you lost your investments due to poor decision making. Ensure that you do not act on instincts are fully aware as to why you want to move your funds out of a fund.