New approaches to investment income I N C O ME
What are your personal income needs? It’s a tough decision, but it’s time to make it. We have reached a fork in the road. The flight to “safer” assets in the face of volatile markets may have worked until now, but record-low yields have changed the game plan. To stay the traditional income course could be a path to greater financial risk, or shortfall in retirement. It’s time for a new approach.
Patrick O’Toole Vice-President, Global Fixed Income, CIBC Asset Management
Whatever your personal income needs may be, it is important to know that creating a strong and steady stream of investment income is not as easy as it once was.
Why you need a new approach With fixed income investments such as GICs and government bonds offering historically low interest rates, traditional ways of generating income may no longer be sufficient – especially after you subtract inflation and taxes.
The fixed income landscape has changed Economic uncertainty across the globe is now the new normal, and risk-averse investors are responding by sitting on the sidelines and investing in extremely low-yielding instruments like GICs. But with interest rates likely to remain low for quite some time, investors should consider income solutions that can boost yields and returns. To provide some additional perspective, the chart below shows the dramatic change in the fixed income landscape over the past 32 years, showing why investors need to look for a new investment approach.
Our Canada Pension Plan (CPP) has evolved When the CPP was launched in 1964, a high ratio of workers to retirees and relatively shorter retiree lifespans meant the plan had ample reserves. But by the 1990s, it became clear that the plan would face a serious cash flow crisis unless it changed its investment strategy. That’s when the CPP Investment Board was established to handle the management of the CPP Fund. Since then, the fund’s equity allocation has grown from just 5% to 66% of total holdings. In addition, almost 20% of the fund is now invested in inflation-sensitive assets, including real estate, inflation-linked bonds and infrastructure. This change in investment strategy by the CPP illustrates the need for adequate diversification within an ever-changing income environment.
Canada Pension Plan Fund1
Long-term Govt. of Canada Bond Yield
March 31, 2012
50% 41.6% 40%
Source: Bank of Canada, Bloomberg *as at June 30, 2012.
31.2% 30% 20%
Source: Bank of Canada Review Autumn 1995.
18% Corporate bonds
n 82% Government bonds n
Canadian Bond Market Landscape (% assets)
Source: Financial Highlights of CPP Investment Board, March 31, 2012.
Now: 2012 n 68% Government bonds n 25% Corporate bonds n
6% Real Return bonds
1% High-Yield bonds
Source: CIBC Global Asset Management as at June 30, 2012.
Demographic shift impacting Canadians
The need for diversification
We are in the midst of one of the greatest demographic transformations that will impact Canadians and the investment industry. Canadaâ€™s population is aging, investors are retiring in record numbers, and they are living longer. Their need to focus on increasing contributions within their investment portfolios is being replaced by an even greater need to generate income or cash flow from their portfolios and increase return potential.
Fixed income investments such as bonds play a vital role in the construction of a diversified investment portfolio. The challenge is that by investing solely in Canadian bonds, you may be missing out on opportunities to diversify your portfolio.
In addition, changes to Old Age Security that raise eligibility from 65 years of age to 67 (effective April 2023) ensure current generations will need to work longer and need additional sources of income.
Adding global yield to your portfolio: Canada represents only 2%2 of the Citigroup World Government Bond Index and 3% of the world equity market capitalization. Investing in Canada not only limits potential opportunities, it also exposes investors to sector, country and currency specific risks. Canadians should consider the entire world of investment opportunities. 3
Global markets deliver higher dividends: For investors who understand and wish to profit from the fact that dividends are a critical source of shareholder returns over the long term, dividend-paying global equities can provide even greater opportunities. 2
Source: Bloomberg as at July 31, 2012. 3 Mellon Analytics as at June 30, 2012.
Yield is everywhere...you need expert managers to help you find the best
1.59% 9% 9%
Canad Canada da
1.66% 66% France
2 2.39% 1.32%
1 51% 1.51%
3 3.26% 26% Greece Gre eece
25.82% 2% 2% 5.96% Italy
0.94% 0 94% 4%
Indonesia n Malaysia M
Source: Trading Economics 2012.
A t a Australia
Consider these income strategies Income mutual funds
Investment income and cash flow are different. Investment income is something you cannot control. It is generated by securities like bonds and GICs, reflecting the current market environment.
Cash flow is something you can control. It’s the amount of income you wish to draw from your investments each month or year depending on your need.
Mutual funds that are designed to generate monthly income can invest in a wide range of income securities such as income trusts, dividend-paying shares, preferred stocks and convertible securities, and are able to benefit from the growth of markets in Canada and abroad. As part of an overall portfolio, a diversified income fund can enhance your cash flow while reducing risk. Primary Benefit: Income generation
Growth-oriented investments With the average retirement period now longer than before, the growth potential of equities is often necessary to stay ahead of inflation and may be an additional source of cash flow over the long term. Primary Benefit: Growth potential over the long term
Diversified income portfolios
Strategies to reduce taxes. Income planning and tax planning go hand-in-hand. Interest income is immediately taxed at your full marginal rate. But (as shown in the table below) other forms of income – such as a return of capital, dividends and capital gains – can significantly reduce or defer your tax bill, and potentially increase the amount of cash that stays in your pocket.
In today’s environment, perhaps the best income strategy is one that combines professional income diversification, tax efficiency and the potential to earn higher cash flow and continue growing your capital over the long term by having a healthy exposure to equities. Diversified income portfolios are able to achieve this goal by bundling several income mutual funds within a single, optimized portfolio. The result is an optimal balance of cash flow, capital preservation, tax efficiency and the growth potential of equities – all within a single solution. Day-to-day investment decisions are handled by a team of portfolio managers who exhibit complementary performance traits and who have unique expertise in a diverse range of income investments. Primary Benefit: Tax-efficient income generation
Return of Capital
Eligible Dividend Income
RRSP or RRIF Withdrawals
What you keep
Based on Ontario’s maximum marginal tax rates. †Your adjusted cost base will be reduced by the amount of any return of capital. If your adjusted cost base goes below zero, then you will realize immediate capital gains on the amount below zero.
Take advantage of these cash flow strategies T-Class mutual fund units
Systematic Withdrawal Plan (SWP)
With T-Class mutual fund units, you can choose an annual cash flow option that’s based on a percentage of your total investment, and will be paid to you every month. If the income earned by your investments is less than your monthly cash flow requirement, the difference is made up with a tax-efficient return of capital distribution (ROC). ROC is generally a distribution in excess of a fund’s net income and net realized capital gains and may reduce the adjusted cost base of your investment. These ROC distributions are tax-deferred until the units are sold giving you a higher monthly cash flow on an aftertax basis.
A SWP is a great way to withdraw a fixed amount from your investments each month, quarter or year, as you decide. If you’re planning to make withdrawals over an extended period – say, five years or longer – you should consider investing in a diversified portfolio that includes some equity exposure, as this provides the growth potential to stay ahead of inflation and offset some or all of your withdrawals. In the chart below, we highlight an example of how this would work. In addition, the income from a SWP is often in the form of capital gains, which means you’ll pay less tax than you would with an equivalent interest payment.
T-Class mutual fund units can be a good choice to minimize tax, especially if you’re still working and earning other sources of income. They can also provide the long-term security of higher monthly income throughout retirement.
Primary Benefit: Customizable cash flow to meet investor needs
Primary Benefit: Tax-efficient cash flow
15 Years of Income Through a SWP 140,000
Total withdrawal over 15 years = $90,000
Initial Investment = $100,000
Market Value = $88,363
Market Value ($)
120,000 110,000 100,000 90,000
$500 withdrawn per month
Source: Morningstar Direct. The above example is hypothetical data for illustration purposes only and is based on the monthly returns of the Canadian Equity Category Average. This example assumes reinvestment of distributions, no additional deposits or withdrawals during the 15-year period. If you withdraw more than your investment is earning, the original investment will begin to reduce.
Benefit from our approach to income With our broad selection of income strategies, income mutual funds and diversified income portfolios, you and your investment advisor can design a comprehensive solution that provides the income you need today. To learn more, contact your investment advisor.
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Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the Renaissance Investments family of funds simplified prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Renaissance Investments is offered by CIBC Asset Management Inc. ™ Renaissance Investments is a registered trademark of CIBC Asset Management Inc.
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