It’s been a while since I’ve dipped into the questions inbox, so let’s see what’s on readers’ minds.
Q – I just read an article about closed end funds (CEFs) which is the first time I’ve ever heard of them. The writer claimed that they pay 7 per cent on average, which I believe in this day is amazing! Some people compare them to ETFs but with a higher risk. Why do we not hear more about them? – Norman L.
A – If it sounds too good to be true, it probably is. Closed-end funds have been around for many years and were once very popular. Then people began to discover some things they didn’t like. For one, many of them trade at a discount to their net asset value, and sometimes that discount is substantial. For another, a fund may not earn enough profit in a given year to sustain its distribution. Instead of cutting the payout it pays back part of your capital.
That said, some of these funds are worth a look. The Canoe Income Fund (EIT.UN-T) is a recommendation of my Income Investor newsletter. It was selected in January 2019 at $10.95. At the time of writing, it was trading at $11.51 and paying a monthly dividend of $0.10 a unit, or $1.20 a year. That’s a yield of 10.4 per cent. The risk is that this is an all-stock fund. If the market crashes, the value of the units will follow. – G.P.
Q – I’m trying to help structure a portfolio for a friend who will soon have very little income when she retires – she will likely be eligible for the GIS (Guaranteed Income Supplement). Her TFSA is maxed out, so we are talking about income from a non-registered account.
My inclination is to buy some stable dividend paying stocks and lock in a yield of say 4 per cent. The problem is that the grossed-up amount of the dividend counts as income for GIS purposes and so will reduce her GIS much more than interest, or, even better, capital gains. It seems that dividends will reduce GIS at 70 cents on the dollar, interest 50 cents, and capital gains 25 cents.
I could buy a growth-oriented portfolio and harvest some capital every year (capital gains) but some years it might go down. Is there any other way to essentially get stable dividend income, but receive it as interest or capital gains?
– Ian K.
A – I have two suggestions to consider. The first is to invest some of her money in a stable mortgage investment corporation (MIC), such as Firm Capital Mortgage Investment Corp. (FC-T), a long-time recommendation of my Income Investor newsletter. Distributions from MICs are called dividends, but they are actually taxed as interest. That means they aren’t eligible for the dividend tax credit and, hence, no need to worry about the gross-up. Of course, the whole amount of the distributions will be taxable, but since she will be in a low tax bracket that should not be a major concern. Firm Capital currently yields just under 7 per cent.
My second suggestion is to look at corporate class mutual funds, which group a large selection of funds within a single corporation. Most major fund companies offer them. The wide range of mandates within the corporation enables you to construct a portfolio that is risk appropriate. All the distributions are in the form of capital gains dividends, non-taxable return of capital, or eligible Canadian dividends. Check the distribution history of any corporate class fund you’re considering before making a decision. – G.P.
Bank mutual funds
Q – What do I need to be aware of when purchasing a bank mutual fund? I have a small amount in my TFSA and have a direct investing account. I am thinking of buying one of these or a bank stock. – Robert J.
A – For starters, a mutual fund will provide broad diversification. Buying a stock is a bet on a single company. If you have a small amount to invest, the mutual fund is the more prudent course.
That said, you need to do some research before you buy. Your financial institution will push their own line of funds but there may be better options. Look especially at past performance, the cost of the fund, and the risk level. If your TFSA account allows stock market trades, also check comparable ETFs before making a decision. – G.P.
Tax advantages of REITs
Q – Can you explain the tax advantages of REITs. I own several of them, particularly in my TFSA. – Brian E.
A – Most REITs do offer some tax breaks in terms of their distributions, but they’re of no value in a TFSA. The units need to be held in an unregistered account.
The composition of the distributions, and hence the tax advantages, will vary from one REIT to another. You can usually find the information on the REIT’s website. For example, in 2020 only about 60 per cent of the payout from RioCan REIT was fully taxable. Almost 18 per cent was in the form of capital gains (taxed at a lower rate). About 23 per cent was return of capital, which is not taxed in the year received. Instead, the cost base is adjusted to reflect such payments, which will increase capital gains tax exposure when the units are sold. – G.P.
Q – I have TFSAs with three institutions. Can I transfer these to another institution so that I can change the investment makeup of the individual TFSAs beyond that offered by the institution in question? – John M.
A – Yes, but it must be done properly or you risk running afoul of the overcontribution rules. Don’t just pull your money out, walk across the street, and open a new plan. The Canada Revenue Agency would consider that to be a new contribution.
Instead, ask the new institution to open a plan in your name and have them arrange to have the assets in your existing plans transferred over. They’ll handle all the paperwork. There may be a transfer fee, which is your responsibility to pay. The whole process should theoretically take just a few days, but you may end up having to wait a couple of weeks. Financial institutions have been known to drag their feet when it involves closing an account. – G.P.
If you have a money question you’d like answered, send it to email@example.com and write Globe Question in the subject line. I can’t guarantee a personal response but I’ll answer as many questions as possible in this space.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.
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