DIY monthly income fund

[Bylo Selhi]

Build your own income fund [Globe and Mail, 27Aug05]

Consider the idea of creating your own monthly income fund. All you need are an on-line brokerage account and a degree of comfort with the idea of buying your own securities.

The benefit of buying yourself is that you'll be in a position to get higher returns from your income investments than the typical fund would provide. Imagine a portfolio that produces enough income trust distributions, bond interest payments and dividends over a year to yield 5 per cent. If you bought this portfolio yourself, then that yield is what you receive.

But if you owned this portfolio through a monthly income fund run by a bank or other fund company, then your yield could be reduced by anywhere from 1.2 to almost 2.5 percentage points by fees that cover the fund's operating costs.

[yielder]

Imagine a portfolio that produces enough income trust distributions, bond interest payments and dividends over a year to yield 5 per cent. If you bought this portfolio yourself, then that yield is what you receive.

Carrick's article is OK as far as it goes. The assumption is that the investor who wants this kind of portfolio is risk averse and is looking for a safe income stream. By including a stock like GAZ.UN, he is reaching for yield and adding a level of risk that the investor may not be able to handle.



There's nothing overly wrong with doing this IF

1. You are satisfied with the current yield.
2. You accept the clear risk of unrealized losses because you have bought a stock that is expensive.
3. You accept the increased risk of signigicant loss that a distribution cut would entail because you have bought when the stock is expensive.
4. You are able to identify when 2. occurs.

My experience in working with investors is that most have no idea of whether a stock is currently cheap, expensive or fairly price. Paying attention to ROB TV analysts will get you this kind of opinion

Desjardins Starts Gaz Metro At Buy, C$24 >GZM.UN.T
9:34am ET (Dow Jones Newswires)

(END) Dow Jones Newswires

08-26-05 0934ET

Copyright (c) 2005 Dow Jones & Company, Inc.

Bottom line? Most investors are better off with one of the bank monthly income funds.

[randomwalker]

I'll take a stab at this. How about reducing risk through diversification. Buy the sector, not the individual stocks/bonds. How about equal dollar amounts of the following,

Barclays Equal Weighted Income Fund BAE.UN current yield 7.01%
Barclays Corporate Bond Fund BAC.UN current yield 5.39%
I Units Canadian Bond Market Index XBB current yield 4.80%

Or take the above three and add a bank, a phone company, a pipeline, and a utility. Keep it simple.

[Springbok]

Imagine a portfolio that produces enough income trust distributions, bond interest payments and dividends over a year to yield 5 per cent. If you bought this portfolio yourself, then that yield is what you receive.

Carrick's article is OK as far as it goes. The assumption is that the investor who wants this kind of portfolio is risk averse and is looking for a safe income stream. By including a stock like GAZ.UN, he is reaching for yield and adding a level of risk that the investor may not be able to handle.

Bottom line? Most investors are better off with one of the bank monthly income funds.

Could be that "most" investors may be better off with a banks monthly income fund, but the size of the portfolio may affect this. It would probably be the best thing for a small portfolio.

In my own case, I have a DIY portfolio designed to provide sufficient annual income to live on. CPP/OAS for two boosts this income.

Our portfolio is spread over 3 accounts (2 registered) made up of 27 bonds mostly with 1-5 yr maturity, 20 stocks (mainly div payers), 4 individual income trusts, 3 diversified trusts, 4 ETF,s and 2 Mutual Funds. This has produced about 5% in income and about 12.5% in Total Return for past 2-3 years.

The income trusts have shown good capital gains - something we did not count on (e.g SIN.UN 60% CG over 2 years plus a 10% distribution yield on purchase price).

Altough I don't particularly like the specifics of Rob Carrick's post, I do think that a DIY investor can put toether a very good income portfolio that will also grow.

BUT, we are well into a good run up in the markets, so someone putting together a portfolio today, may have some trouble choosing investments. Furthermore, those of us who already have such a portolio need to be vigilant because moreand more we hear of the possibilty of high energy costs causing a slow down in the world economies.

[scomac]

Altough I don't particularly like the specifics of Rob Carrick's post, I do think that a DIY investor can put toether a very good income portfolio that will also grow.

Agreed. I was somewhat surprised that Carrick didn't approach this from an asset class perspective much as randomwalker has alluded to with the use of ETFs/CEFs.

I'd be very hard pressed in the current market environment to piece together such a portfolio that I was happy with the holdings and the price I was paying.

Scott

[yielder]

I think that the 9 security portfolio that Carrick has constructed is a recipe for disaster. It's inadequately diversified, has lumpy cash flow, and has some high risk individual securities in it - Rothmans and GMAC

At ~$25/equity trade, it's impossible to get a 50%bonds/50% equity, 20-stock portfolio at reasonable cost with less than a $100,000 portfolio. That size portfolio will cost you .5% in commissions. Because most people have neither the time, knowledge or discipline to properly track stocks, you need at least 20 stocks to reduce the impact of nasty surprises.

It's very hard to beat the bank monthly income funds even with the MERs. with the current trailing twelve month yields ranging from TD's 2.76% to BMO's 7.3%. You get a monthly income stream which makes budgeting a great deal easier than quarterly or semi-annual payments. I think this monthly payment requirement makes style drift or performance chasing by the manager difficult. The downside is that there is the risk of trying to maintain the payout by reaching for yield which means increasing the trust weighting, making sector bets, or extending bond maturity.

Sometimes the best DIY isn't to DIY.

[yielder]

Agreed. I was somewhat surprised that Carrick didn't approach this from an asset class perspective much as randomwalker has alluded to with the use of ETFs/CEFs.

Because he often writes financial porn. From GlobeInvestorGold on 8/19: "now seems a poor time to add ETFs. The point here is that the rally that helped the indexes beat actively managed funds has lasted the better part of three years now, which is a long time. At some point, maybe later this year or possibly early in 2006, the market will either pause or fall into a decline. In buying ETFs now, you could well be getting in close to the top of the market. If you don’t like the idea of market timing and really want to add some index exposure to your Canadian equity holdings immediately, then try a dollar-cost averaging approach where you gradually accumulate a position. Remember, indexing works great in a hot market, but it also means you’ll participate in the cold spell that follows."

[Springbok]

It's very hard to beat the bank monthly income funds even with the MERs. with the current trailing twelve month yields ranging from TD's 2.76% to BMO's 7.3%. You get a monthly income stream which makes budgeting a great deal easier than quarterly or semi-annual payments. I think this monthly payment requirement makes style drift or performance chasing by the manager difficult. The downside is that there is the risk of trying to maintain the payout by reaching for yield which means increasing the trust weighting, making sector bets, or extending bond maturity.

Sometimes the best DIY isn't to DIY.

Just looked at Total Return of some of these funds:

Code: Select all

Fund                                        MER         5yr %       3yr%
--------------                             ----          -------       -------
TD Monthly Income                          1.55         13.8         17.4
RBC                                        1.19         12.5         14.1
CIBC                                       1.44         11.8         14.1
BMO                                        1.57          8.5          9.8

By comparison, the TSX60 as measured by the Iunits ETF XIU has an MER of 0.17%, 3yr return of about 17% and 5 yr return of about minus 4% (rough calculations).

At present, these monthly income funds are 50-65% in equities. How did they survive the downturn in the markets that hurt the index? Presumably they must have moved from equities into bonds?

I am surprised by the MF returns - RBC Monthly Income is one that I own, but I just use it to mop up dividends and distributions in our registered accounts.

If a mutual fund can provide this type of return - Why would an investor invest in a portfolio of dividend growing stocks as you have previously suggested? (Serious Question )

[N. Vestor]

Springbok has asked a very good question and I would also welcome comments and opinions on this.
While reviewing my portfolio recently, I noted that CIBC Monthly Income was one of my top performers. It provides decent monthly income, good capital appreciation and it performed very well during the last bear. It would seem to meet all of my needs.
If these are that good, what is wrong with a portfolio of just the top three monthly income funds (for the equity part of a portfolio )?

[DanH]

Springbok has asked a very good question and I would also welcome comments and opinions on this.
While reviewing my portfolio recently, I noted that CIBC Monthly Income was one of my top performers. It provides decent monthly income, good capital appreciation and it performed very well during the last bear. It would seem to meet all of my needs.
If these are that good, what is wrong with a portfolio of just the top three monthly income funds (for the equity part of a portfolio )?

During market declines like 1994 and 1998, no income trust fund would hold up nearly as well. For some historical context, read this older article, starting on the third page with the section titled Risk (and the associated table).

[jiHymas]

Just looked at Total Return of some of these funds:

Code: Select all

Fund                                        MER         5yr %       3yr%
--------------                             ----          -------       -------
TD Monthly Income                          1.55         13.8         17.4
RBC                                        1.19         12.5         14.1
CIBC                                       1.44         11.8         14.1
BMO                                        1.57          8.5          9.8

By comparison, the TSX60 as measured by the Iunits ETF XIU has an MER of 0.17%, 3yr return of about 17% and 5 yr return of about minus 4% (rough calculations).

At present, these monthly income funds are 50-65% in equities. How did they survive the downturn in the markets that hurt the index?

XFN (TSX Financials ETF - will be the core of any so-called dividend fund)
5-year annualized +12.9%
3-year annualized +16.9%

What downturn are you talking about?

[Ron Mann]

Just looked at Total Return of some of these funds:

Code: Select all

Fund                                        MER         5yr %       3yr%
--------------                             ----          -------       -------
TD Monthly Income                          1.55         13.8         17.4
RBC                                        1.19         12.5         14.1
CIBC                                       1.44         11.8         14.1
BMO                                        1.57          8.5          9.8

By comparison, the TSX60 as measured by the Iunits ETF XIU has an MER of 0.17%, 3yr return of about 17% and 5 yr return of about minus 4% (rough calculations).

At present, these monthly income funds are 50-65% in equities. How did they survive the downturn in the markets that hurt the index?

XFN (TSX Financials ETF - will be the core of any so-called dividend fund)
5-year annualized +12.9%
3-year annualized +16.9%

What downturn are you talking about?

About three years ago, I restructured my equity portfolio and bought for my Canadian portfolio (mainly) Barclays ETF. Here are the annualized returns.
XIU 17.4% TSE60
XEG 37.2% Energy
XFN 18.8% Financials
XGD 19.2% Gold
XMD 18.0% Mid Cap
XRE 18.2% REIT

Pretty interesting to me that except for XEG all the ETF are pretty close (I know that over 10 years 19.2% is significantly better than 17.4%)
Last three years have been pretty good for DIYers using ETF.

[yielder]

At present, these monthly income funds are 50-65% in equities. How did they survive the downturn in the markets that hurt the index? Presumably they must have moved from equities into bonds?

I don't know specifically what they did but I suspect they maintained their 50/50 +/- 15 weighting. TD says that "the fundamental investment objective is to provide a consistent level of monthly income with capital appreciation as a secondary objective." The equity portion of the portfolio is made up of quality dividend payers and yield goosing trusts. In a normal market downturn, the dividend provides a price floor since a declining price will make the increasing yield attract buyers. There's a good chance that they were adding equites wherever they could as the market declined rather than running for cover.

RBC Monthly is the oldest of these funds by about 10 months. It weathered the Asian Contagion quite well. All of them performed more or less like RBC during the post-dot.con market.

If a mutual fund can provide this type of return - Why would an investor invest in a portfolio of dividend growing stocks as you have previously suggested? (Serious Question )

If an investor has the time, interest, knowledge, and discipline, he'd invest in a portfolio of dividend paying stocks in order to pocket the MER. Depending on his perception of and taste for risk, he would add fixed income (some combination of bonds, GICs, preferreds, ETFs, bond funds).

Since most investors don't have the time, interest, knowledge, or discipline, I normally suggest that they pay someone to do it for them.

One of the big problems with mutual funds is style drift - managers chase performance and in the process fall on their faces. Repeating myself, "You get a monthly income stream which makes budgeting a great deal easier than quarterly or semi-annual payments. I think this monthly payment requirement makes style drift or performance chasing by the manager difficult. The downside is that there is the risk of trying to maintain the payout by reaching for yield which means increasing the trust weighting, making sector bets, or extending bond maturity. "

If these are that good, what is wrong with a portfolio of just the top three monthly income funds (for the equity part of a portfolio )?

You'll get a fair bit of overlap in the equities. They have a sizeable bond component so you can't consider them as equity. They may also have a sizeable trust component so you have to take that into account if you have trusts.

During market declines like 1994 and 1998, no income trust fund would hold up nearly as well.

True but these aren't income trust funds despite their trust holdings. I'd label them income oriented balanced funds.