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Mutual Fund Income Solutions

 

The investor’s need for income has not changed, but the markets have evolved considerably. Income-investors are looking for investments that generate regular income (i.e. interest income or dividend income) to fund their retirement or supplement their day-to-day lifestyle needs. Our mutual fund strategy reports help keep you on top of these changes. Historically, income-investors have relied on a variety of sources to find income ranging from simple bank savings accounts, GICs, Bank of Canada Bonds, to income-generating mutual funds.

 

Inflation, a constant thorn that erodes consumer’s purchasing power, has always been an income-investors nemesis. Today’s low yielding environment has really transformed how income-investors are generating sufficient income to fund their lifestyle or retirement.

 

Bank of Canada 10 Year Government Yields

 

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Source: BMO Asset Management Inc. Bloomberg Data. Data as of May 4, 2015.

 

 

Falling interest rates have led to income investors enjoying a multi-decade fixed income bull market. Many are asking where interest rates will go next. While no one has a crystal ball predicting the future of interest rates, what we know for certain is that finding reliable sources of income going forward has become a much more daunting task.

 

Buy-and-hold bond strategies and GICs are no longer enough to meet the investor’s income needs. Today’s investors need to diversify and seek out alternative income solutions to meet their needs. Broadly speaking, these income solutions fall under three categories:

 

  1. Fixed income solutions
  2. Balanced income solutions
  3. Equity income solutions

Fixed Income Solutions

 

Fixed income solutions are a source of income that can provide stability in an investor’s portfolio through the benefits of diversification. Holding fixed income solutions can help to mitigate some of the risks associated with equity investing and preserve capital in equity market downturns.

 

The traditional role of fixed income in an investor’s portfolio has not changed in light of today’s low yielding environment. However, actively managed fixed income strategies have become even more important today. The low yielding environment today has meant market opportunities are shrinking for bond investors employing the traditional buy-and-hold strategy.

 

Actively managing duration and credit, employing currency overlays, and opportunistically investing in global and emerging market bonds are critical to help bond investors come out ahead.

 

BMO Mutual Funds offers a suite of innovative fixed income solutions that are actively managed to take advantage of opportunities in today’s low yielding environment.

 

Learn more about BMO Mutual Fund’s fixed income solutions here

Balanced Income Solutions

 

For many investors, balanced income solutions are one-ticket products that can serve as the core holding that not only provide market growth via capital appreciation, but also generate a stable stream of income from the underlying holdings. Investors may also choose to use a satellite investment to compliment and customize their core balanced income solution for their unique needs.

 

Balanced income solutions invest in a diversified mix of assets including dividend equities, preferred equities, government bonds, corporate bonds, REITs, etc. Some of these solutions may also actively manage the asset allocation to best take advantage of future market opportunities.

 

To meet the evolving needs of investors, BMO Mutual Funds offers a wide suite of balanced income solutions.

Equity Income Solutions

 

For the income-seeking investor, equity income solutions offer the highest potential for growth, while delivering regular dividend income.

 

Dividend investing delivers market exposure with lower volatility, while providing stronger risk-adjusted returns than the broad equity markets. Dividends have historically always played a significant role in driving total equity returns.

 

Annualized Rate of Returns - 1970 to 2015

 

graph

 

Source: BMO Asset Management. Morningstar Direct.

 

 

Not all dividend strategies are created equal. Actively managing security selection and sector allocation can exploit significant outperformance opportunities. For equity income solutions with global mandates, managing the macro portfolio drivers such as currency and region exposure also play a big role.

 

To meet the evolving needs of investors, BMO Mutual Funds offers a wide suite of equity income solutions.

T-Series Tax-Smart Cash Flow

 

T-Series are for investors seeking a tax-efficient, predictable source of cash flow outside their registered accounts (i.e. RRSP, TFSA, RRIF, etc.).

 

T-Series investors receive a monthly distribution at a predefined annualized rate (i.e. T6 would mean 6% annually), which is calculated based on the Net Asset Value ("NAV") as of December 31st of the prior year. The monthly distribution to the client is simply the annualized rate divided by 12.

 

T-Series can transform a mutual fund investment, which may otherwise provide limited or no regular distribution, into ones which can deliver a predictable stream of tax-efficient monthly cash flow. Investors in the T-Series receive monthly cash flow at an accelerated rate compared to non T-Series. Investor’s holding T-Series products can expect that a higher percentage of their distribution each year is classified as Return of Capital ("ROC").

 

For more information on Series T, refer to the FAQ "What are the differences between each of the Series of the Funds?" or see our full list of BMO Mutual Fund Series T offerings.


Strategies to Meet Long-Term Investment Goals

 

Access the Long-Term Investing brochure for an overview of the benefits of staying invested for the long term, keeping focused on the big picture and choosing the right investments. Investors require a portfolio solution that can deliver strong long-term investment returns that outpaces Canadian's annual cost of living increases.

 

The longer the time horizon, the better the investor is able to cope with the day-to-day market noise (or volatility). More often than not, focusing on headlines and daily market volatility can serve as a distraction and might derail the investor from seeing the big picture.

Whether it is to save for their retirement, a dream home, or their child's post-secondary education, every investor has their own personal investment goals. Most importantly to help reach those goals, it’s best to start with a plan and consider these strategies when investing for the long-term.

 


Mutual Fund Tax Management

 

Much like any other investment product, whenever you buy and sell a mutual fund there are potential tax implications that should be considered. As investors, we typically spend most of our time trying to ensure that we have the right investments in our portfolio, scrutinizing our decisions based on an investment’s rate of return and risk characteristics. However, it’s not always this simple – and what we earn, isn’t necessarily what we get.

 

We often don’t think about our investments in the context of taxes, but understanding after-tax returns leads us to becoming better investors, and can be a major influence on whether or not we reach our investment goals.

 

When it comes to mutual fund investments, taxes that investors are ‘on the hook’ for generally come from 2 different sources:

 

  1. Taxes on the distributions an investor receives from a mutual fund
  2. Taxes on a disposition due to selling a mutual fund outright or switching from one mutual fund to another

What you need to know about mutual fund distributions

 

Whether we rely on the income from investments to manage regular day-to-day expenses or if it’s simply because we prefer the benefits of income investing for long-term growth, it’s evident that income investing has become an important part of our portfolios. Depending on your investment goals, there are generally 2 options when a mutual fund makes a distribution:

 

  1. Receive the distribution in the form of a cash payment
  2. Reinvest the distribution back into the fund by purchasing additional units

A mutual fund can be set up as a trust or a corporation. The main difference between an investment in a trust and a corporation is in how the entity and your investment in the entity are taxed. This is generally more important if you are investing outside of a registered plan.

 

A mutual fund that is a trust will, each year, distribute enough of its net income and net realized capital gains so that the fund will not be subject to normal income tax. The fund will flow its taxable income through to investors in the form of distributions. Investors are generally taxed on this income as if they earned it directly.

 

A mutual fund that is a corporation will generally flow its Canadian source dividend income through to investors in the form of ordinary dividends and its net realized capital gains through to investors in the form of capital gains dividends. The fund will pay tax on other types of income (such as interest or foreign source dividends) if that income is more than its deductible expenses and investment losses.


Types of Distribution Description Tax Treatment Examples
Interest Income that’s earned from investments such as GICs and bonds Generally treated as ordinary income and taxed at the investor’s marginal tax rate BMO Core Bond Fund

BMO Core Plus Bond Fund
Canadian Dividends Income that’s earned from dividends paid by Canadian companies The investor can treat the distribution as if it were a dividend from a Canadian company, which may qualify for a lower effective tax rate BMO Dividend Fund

BMO Monthly High Income Fund II
Capital Gains Realized when an underlying investment within the fund is sold for more than its purchase price The investor can usually treat the distribution as if it were a capital gain realized by him or her. Half of such a capital gain distribution has to be included in the investor’s income. BMO Canadian Lg Cap Equity Fund

BMO U.S. Equity Fund
Foreign Non-business Income Income that’s earned from foreign investments, such as shares of U.S. companies. The investor may be able to claim a foreign tax credit for foreign tax paid by the mutual fund. BMO U.S. Dividend Fund

BMO Global Dividend Fund
Return of Capital When a fund distributes more than its net income and net realized capital gains, which may occur if the fund has a stated fixed distribution amount. Not taxable in the year received, but reduces the adjusted cost base (ACB), which generally results in a larger capital gain (or smaller capital loss) when the investment is sold BMO Monthly Income Fund

BMO Balanced Yield Plus ETF Pt

 

Note: Investments held in registered accounts (such as RRSPs and RRIFs) are generally tax deferred until the investments are withdrawn.


What you need to know about tax consequences when redeeming or switching your mutual fund

 

The redemption of mutual fund securities is a disposition. If securities are held in your non-registered account, you will generally realize a capital gain or capital loss when you redeem or otherwise dispose of your securities. The capital gain or loss is the difference between the proceeds you receive and the ACB of your redeemed securities, less any cost of disposition.

 

If you switch your securities of a fund for securities of another series of the same fund, or if you switch between mutual funds within a corporate class structure (i.e., BMO Global Tax Advantage Funds), the switch is made either as a redesignation or a conversion of your securities, depending on the situation. In other words, the switch should occur on a tax-deferred basis so that you do not realize a capital gain or capital loss on your switched securities. Any other type of switch involves the redemption of your securities, which is a disposition for income tax purposes.

Capital gains must be reported for tax purposes in the same year they are realized. Because only 50% of the gain is taxable, capital gains are taxed more favorably than other types of income. Most capital losses can be used to offset capital gains to reduce an investor’s tax liability. If, however, an investor does not have any realized capital gains in the same year that a capital loss is realized, the loss can be carried back and applied against realized capital gains from any of the previous 3 years. Investors are also allowed to carry the loss forward indefinitely to offset gains in future years.

 

Depending on your investment goals, it may make sense to consider investment strategies within your portfolio that are tax efficient. Speak to your advisor or tax specialist to get details on tax-efficient strategies for your portfolio.



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