Market Volatility Creates Opportunity for Investment Income

Are you looking to create income from your investments? In the past if you answered yes to this question, you would head out to the bank and look for the best GIC rate – 10%, 11% or 12% and invest so that you lived off the interest and guaranteed the capital.

Unfortunately interest rates are not so generous. As a result, many investors have turned to mutual funds to create higher flows of income.

Systematic Withdrawal Plans (SWP)

Templeton and Trimark have made Systematic Withdrawal Plans (SWPs) famous. For example, you would invest in a mutual fund like the Templeton Growth Fund or the Trimark Fund and take out a specified level of income. You arbitrarily set a reasonable income like 7% or 8% for example. Not only has the historical performance of these funds created tax preferred income but they have also provided the investor with significant capital appreciation.

Income funds

The one downside to a Systematic Withdrawal Plan is the tracking of the tax can be a nightmare. Every sell changes the average cost base and tax tracking can be time consuming, costly and confusing.

Alternatively, more and more mutual fund companies have created income funds. These funds are some of my favorite ways to generate income because the mutual fund company tracks the taxes for you.

The way these funds work is simple. The mutual fund pays out a regular stream of income in the form of a distribution (sometimes called a dividend). The level of income largely depends on the price that you buy these funds. The recent market volatility has made these funds cheaper and also more attractive from an income standpoint.

Let’s take a look at some examples of income funds:

Fund Current Price (Apr 6, 2001) Distribution per unit Yield on capital Cost of $1000 of pre-tax income Cost of $1000 of after-tax
Clarington Global Income 9.54 0.08 10.06% $9,937.50 $13,197.21
Merrill Lynch Canadian Income Trust 7.74 0.062 9.61% $10,403.23 $13,815.70
Clarington Canadian Income 10.01 0.08 9.59% $10,427.08 $13,847.39
CI Canadian Income 9.57 0.075 9.40% $10,633.33 $14,121.29
AIM Canada Income Class 5.13 0.038 8.89% $11,250.00 $14,940.24
GGOF Guardian Monthly High Inc. Classic 8.63 0.06 8.34% $11,986.11 $15,917.81
Talvest Millennium High Income 8.77 0.06 8.21% $12,180.56 $16,176.04
Bissett Income Class A 11.95 0.08 8.03% $12,447.92 $16,531.10
Synergy Canadian Income 4.81 0.03 7.48% $13,361.11 $17,743.84
Signature High Income 10.79 0.065 7.23% $13,833.33 $18,370.96
Talvest Dividend 15.01 0.083 6.64% $15,070.28 $20,013.65
Elliott & Page Monthly High Income 10.03 0.055 6.58% $15,196.97 $20,181.90
AIC Income Equity 4.83 0.025 6.21% $16,100.00 $21,381.14
AIC American Income Equity 4.89 0.025 6.13% $16,300.00 $21,646.75
AGF Canadian High Income 9.68 0.046 5.70% $17,536.23 $23,288.49
StrategicNova Canadian Dividend 11.02 0.05 5.44% $18,366.67 $24,391.32
GGOF Guardian Monthly Dividend Classic 8.35 0.035 5.03% $19,880.95 $26,402.33
5 Year GIC 5.00% $20,000.00 $33,333.33
Signature Dividend Income 13.49 0.045 4.00% $24,981.48 $33,175.94
Signature Dividend 12.5 0.04 3.84% $26,041.67 $34,583.89
Mac Ind Dividend Growth 17.2 0.05 3.49% $28,666.67 $38,069.94
Spectrum Dividend 14.01 0.04 3.43% $29,187.50 $38,761.62
* after-tax assumption: Based on the equivalent of dividend income at a 40% marginal tax rate

Not all income funds are the same. Income funds differentiate themselves not just by what they pay but more by what they invest in. Most income funds will invest in Income trust units, Real Estate Investment Trusts (REITs), Stocks and Bonds. Some will focus on only one asset type while other funds will diversify among different investments. It is important to take a look at the holdings and mandates of the fund to determine their value.

How much do you need to earn a dollar of income?

It’s the million-dollar question. The last column in the chart shows how much you will need to invest to earn $1,000 of pre-tax income. Obviously, the higher the yield, the less capital you will need to generate the same dollar of income. For example, you need to invest $9,937.50 in the Clarington Global Income Fund to generate $1000 of pre-tax income. On the other hand, you will need to invest twice as much money in the StrategicNova Canadian Dividend Fund to generate the same $1000 of income.

Tax smart investing

Not only are the yields of these income products higher than GICs but they are also much more tax efficient. Most of these products have an underlying tax benefit. They are designed to keep investment income tax preferred and defer income into the future.

In the last column, we look at how much capital you will need to generate $1000 of after-tax income. The assumptions are over generalized because each fund will have significantly different forms of income from a tax perspective. In most cases, the funds will be more tax efficient than presented in this article.

If we incorporate tax efficiency which is very important to non-RRSP investing, then you will see that you will need $13,197.21 invested in the Clarington Global Income fund to generate $1000 after tax per year. If you are investing in GICs, which have poor tax efficiency, you will need to invest $33,333.33 to generate the same $1000 of income. That’s over 150% more capital to generate the same after-tax cashflow.

More perspective

The most important perspective I can provide is nothing is guaranteed. These investments are all mutual funds and they do not guarantee that the income will not change or that the capital will not fluctuate. So it’s not all blue sky and roses. There is risk. Remember that rewards come with some risk. The bottom line is if you are looking to create extra income of your investments, these income funds are worth a good look. Make sure you not only consider the pre-tax yield but you must also understand the composition of the funds and determine how much of that yield you will keep after-tax.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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