Monthly Income Funds have been generating positive returns during a time of declining interest rates and low-performing stock markets.
Once you retire and stop accumulating wealth, your investment objectives change dramatically. Up until now you were trying to maximize the growth of your portfolio, while maintaining the relative safety of the principal. You relied on your earnings to provide you with income. Now instead you may find that you have to look to your investment portfolio as the source of your income. Yet you should consider not just the yield of your investment, but the tax implications on that income. You should be focusing on maximizing your after-tax income.
What is the best way to achieve this?
With rates barely above 40-year interest rate lows, it is not hard to understand why the search is on for alternate investments that pay a high yield. Many new investment products are being introduced that claim to fill the gap. One of these products that have enjoyed a great deal of popularity recently is the Monthly Income Fund. This type of fund has been generating positive returns during a time of declining interest rates and low-performing stock markets.
How do Monthly Income Funds work?
The funds comes in many different versions, with most having some combination of income trusts, bonds, short-term cash investments, and dividend-paying common and preferred shares. Each of these asset classes may be managed by only one manager, or in the case of some managed accounts, the best manager for each asset class is tasked with maximizing returns. This diversification softens the blow for the Monthly Income Fund if one area of the investments decline.
On a monthly basis, income is sent to the unit holders based on a pre-determined annual rate of return. This income is taxed at a preferential rate due to the fact that, although some of the income is interest (fully taxed), some is in the form of dividends (tax preferred), and the rest is return of capital (not taxed). The unit value of these funds may fluctuate with valuation of the underlying assets, but the income remains constant every month.
What are the asset classes that could make up a Monthly Income Fund?
Income Trusts are sometimes part of a monthly income fund. Within this class, there are many different types of industries, ranging from oil and gas to real estate to pet food manufacturers. Income Trusts are designed to provide a steady flow of income, which is distributed to unit holders on a monthly basis. Usually a portion of that monthly distribution is considered a return of capital, which means the income is not taxable. Until the change in taxation announced in October 2006, Canadian investors had been turning more to income trusts, attracted by the combination of tax-advantaged cash flow and rates of return that are considerably greater than deposit returns. Income Funds holding Income Trusts are expected to mostly divest themselves of their positions in advance of the changes in tax treatment at the end of 2010. Only real estate income trusts retain their tax preferred treatment after that date. In the meantime, Monthly Income Fund Managers continue to invest in income trusts although many are much more selective since the announced change.