MANY investors have been caught out by fund companies that promise consistently high monthly income figures but often fail to deliver.
They target conservative investors that need income in this low-interest-rate environment. Their distributions are far too high and the products are marketed as if their returns are guaranteed (which they are not). Please beware of these types of fund as they are too good to be true.
Several monthly income funds run by well-known financial institutions have set payments often around 6 per cent annually, paid in monthly distributions. However, when you investigate how these funds plan to come up with that 6 per cent, it sheds some light on serious problems.
Many of these portfolios have not managed to earn this rate of return, so how are they going to pay you that amount?
For example, one of these monthly income funds managed by one of the larger companies recently cut its monthly distribution from the targeted 6 per cent to 4 per cent. This really shouldn't come as a surprise to anyone, considering the fund had posted a total return from dividends, interest and capital gains of only 3.1 per cent annually over the past three years! In order to make up the difference, and continue paying the promised 6 per cent distribution, they actually gave investors back their own money, thus reducing the value of the overall investment and eating into its fund's capital.
How do fund companies get away with these unrealistic distributions that they can't pay? The details are always in the fine print of the fund company's prospectus; unfortunately most people do not read these 50-page documents that are filled with investment jargon!
The financial advisor or the investment professional should be upfront and explain to investors that the desired distribution is not guaranteed and if the expected return is not achieved, the fund company will beef up the distribution by giving investors back their own money. Going through an underperforming market certainly makes it difficult for these funds to attain these ambitious targets. The expectation is that the fund will perform better than the expected payout, but this hasn't been the case, as I have stated many times before, many mutual funds unfortunately do not beat the index and have provided negative returns over the past five years.
So what's the proper way to calculate the income that a client would receive from their portfolio? As I specialize in retirement planning, the No. 1 question I receive is "How much can I take from my portfolio without reducing the capital?" In my opinion, the correct way to calculate the yield is from what's called the internal yield, which can fluctuate but only includes the dividends and interest that are actually being paid into the portfolio and not the estimated growth. As growth can fluctuate, it really isn't accurate to include it in the income for a client's estimate.
For investors who are suspicious of certain funds, remember if it sounds too good to be true then it probably is. There is no way to conservatively and consistently pay 6 per cent in this low-interest-rate environment. A proper income-producing portfolio will pay around 4 to 4.5 per cent from dividends and interest in this market. Again, this does not include growth so this is not the total return expected. Investors should always evaluate their returns annually with their advisor, so if there has been some extra growth that year, they can feel free to reinvest or take a well-deserved vacation!
Lori Pinkowski is a portfolio manager and senior vice-president, private client group, at Raymond James Ltd., a member of the Canadian Investor Protection Fund. This is for informational purposes only and does not necessarily reflect the opinions of Raymond James. Lori can answer questions at 604-915-LORI or lori.pinkowski@raymondjames. ca. You can listen to her every Friday on CKNW at 5: 35 p.m.
