Fall 2009 Newsletter

In view of the recent market instability it seemed appropriate to pen this newsletter and provide some perspective as well as identify new opportunities for generating income. Equity markets have recovered smartly in recent months after bottoming out in early March. The S&P/TSX index started the year at 8,987 points and today is trading in the range of 10,695 points, which represents a gain of approximately 19%. Media headlines continue to be mixed, however, many knowledgeable commentators (David Gartman to name just one) feel the worst is behind us and that the global economy is slowly recuperating. In the U.S. jobless claims are declining, retail sales, home sales, and mortgage sales are improving and President Barack Obama was recently quoted as saying “he is seeing glimmers of hope in the economy”.

Now is a great time to revisit your investments and review your current asset allocation in light of your investment goals and objectives. There are some interesting planning opportunities that are available along with some effective alternatives for increasing retirement income.

Where should you invest your money for solid long-term growth?

The volatility of last year and its impact on the average rates of return of mutual funds has caused many people to rethink their investment choices - some funds had 5 years growth wiped out by last year’s declines. While it’s important not to predicate all your planning decisions on one bad year I think it is helpful and instructive to look at the question posed in the heading. In the past a typical portfolio would have a certain proportion of money in foreign equity funds, GIC’s or a bond fund for the fixed income portion and an assortment of Canadian equity funds. The foreign equity component proved especially problematic last year and for the previous few years. International markets declined significantly and when this was combined with the ascent of the Canadian Dollar relative to other currencies the impact was severe.

When we look at the performance of some of the best Canadian balanced funds the fable of the Tortoise and the Hare comes to mind; they may not go up as dramatically as a pure equity fund does but they keep more of their gains when markets decline. Listed below are a few of our favourite balanced funds and their rates of return.



It is interesting to note that the Fidelity Canadian Balanced Fund, which contains approximately 50% of its holdings in bonds outperformed the S&P/TSX equity index over the past 10 years by a significant margin. This is particularly remarkable given the S&P/TSX index is all equities and does not include any bonds. Interest rates are now quite low and a critical question facing all investors in the accumulation stage is where to put their money for good medium and long-term growth; a balanced fund may be the best choice. Incidentally these rates of return outperformed many of the more sophisticated “discretionary money manager” type investments.

Retirement is all about Income!

My dad used to say that, “wealth wasn’t capital, it was income” - you can be asset rich and cash poor! The real challenge at retirement is how to turn your assets into sufficient and reliable income. Let’s look at some options for doing this.

Pension Income: Many retirees have pensions from their former employer, yet those who were self-employed and will typically be funding their retirement from investments and may not have inadequate pension income. A pension is usually a fixed amount of monthly income that is guaranteed for life based on one or two persons’ lives. An individual can buy the equivalent of a pension by purchasing an annuity. Like a pension it can be based on one or two persons’ lives and when purchased with non-RRSP funds a significant portion of the payments are non-taxable.



Clearly the Annuity produces far more after-tax or spendable income than a GIC. This is an advantage when you are concerned about the clawback of your Old Age Security payments or when you need to improve your current retirement income. In return for more income and less tax you reduce your estate by the purchase price of the annuity unless you attach a guarantee period or insure the capital in which case you can restore this capital to your estate on your death. The ability to purchase the insurance portion does depend on your health. The next example looks at an insured annuity where the retiree wishes to replace capital used to purchase the annuity on his or her death.



Based on these numbers, the retiree who opts for the insured annuity should realize an approximate annual equivalent GIC yield of 7.08%. This means that unless interest rates rise beyond 7% at some point in the future he or she will be receiving significantly more income, paying less tax, and having their estate replenished with $ 100,000 of tax-free capital on their death. If the retiree opts for the previous example of an uninsured annuity then their annual equivalent GIC yield should be approximately 10.625%, substantially more income than they are ever likely to receive from a GIC or Bond. The retiree also has the option of insuring half of what they invest in the annuity, which would give them an annual equivalent GIC yield of approximately 9% per year.

All of these calculations are based on a male and female age 70; if you are younger or older or if it is based on a single person the rates will vary. Generally the older you are the better the pension rate or annuity rate.

Investment Income: This type of income is generally comprised of interest, dividends, and capital gains. Dividends and capital gains are taxed more advantageously than interest - an investment yielding a 4% dividend would be the equivalent to finding a GIC or Bond yielding approximately 6%; and only half of a capital gain is subject to income tax. Investments that yield this type of income are not guaranteed like GIC’s, but some of them have had very steady and reliable income streams for many years.

For example, the CI Signature High Income fund is a Canadian balanced fund, which is invested approximately one-half in corporate and government bonds and one-half in income trusts and dividend bearing stocks. It has maintained an average distribution rate of 7% since its inception in December 1996. Even though the unit value of the fund fluctuates they have been very successful in maintaining their distributions in up and down markets. Compare investing $ 100,000 in GICs at current rates to investing $ 100,000 in this fund. Please note that unlike the GIC the distributions from the balanced fund are not guaranteed.



If you are able to tolerate some fluctuation in your capital this approach can be a good option to combine with your guaranteed investments. Over the past 10 years even with a 21 percent loss in 2008 this fund has produced an average annual yield of approximately 9%. This means that the investor’s capital has actually grown while they have received their income. Remember, however, that past returns are not guarantees of future performance.

There are a few good other funds too like the Optima Dividend Fund which is a pure dividend fund producing around 3.75% of annual dividend income which due to dividends preferential tax treatment would be like receiving approximately 6% in annual interest.

Guaranteed Investment Funds

Talking about these investments now is a little bit like the farmer who closes the barn door after the horse escapes, the horse in this metaphor being equity returns for 2008, but there is merit to this investment option for those investors who want a safety net for their equity investments. Guaranteed Investment Funds are mutual funds which have some important guaranteed minimum benefits attached to them. The have been available for years but it is only recently that these guarantees have been modified to include a guaranteed income stream for life and it was this change that made them so attractive for retirees.

An example will help to explain how these products work. Assume you deposited $100,000 into Manulife’s Income Plus Fund in May of 2008 and directed that your investments were to be split into two balanced funds, Fidelity Canadian Asset Allocation and CI Harbour Growth & Income. Your plan was to leave this money alone for a few years and then start receiving an income at age 65 in 2013. Please note these numbers are based on hypothetical market values for the years listed.



The G.W. Balance (Guaranteed Withdrawal Balance) represents the guaranteed base that is used to determine your guaranteed lifetime income stream which can be started in any year once you reach the age of 65(if you start the income prior to 65 the income is guaranteed for 20 years). Assume for example you turned 65 in 2013 (see bolded type column in table) and you wanted to start your lifetime income, it would be 5% of $125,000 or $6,250 paid annually for life. Every three years up until age 80 on the policy anniversary they would compare the current market value to the GWB value and reset the GWB equal to the market value if it was higher.

Once you enter the income stage the Guaranteed Death Benefits and Maturity Benefits are reduced by the amount of your annual withdrawals. These are complicated contracts and it takes some time to fully understand the various features of them. In a nutshell if you would like have some of your capital invested in the stock markets, but need the comfort of floor guarantees, both for your future income and for the estate, it may be beneficial to discuss this option.

The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources ,however, no warranty can be made as to its accuracy or completeness. Commissions, trailing commissions, management fees, and expenses may all be associated with mutual fund investments. The indicated rates of return are the historical annual compounded total returns including changes in unit/share value and reinvestment of all distributions/dividends. They do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returens. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Before acting on any of the above, please make sure to read the prospectus and see me for individual financial advice based on your personal circumstances. Investment advice and mutual fund sales are provided through Assante Financial Management Ltd. Non-securities related financial planning and insurance are provided through Halsey Financial Group.

202-4450 Chatterton Way, Victoria, BC, V8X 5J2 Phone: 250-475-6700 Fax: 250-475-6777 Email: roda@halseyfinancial.com