TaxBites – May 2014

Protect Insurance continues to provide the life and income-protection expertise that professionals have relied upon for years. In addition, we are now pleased to offer a complete suite of financial, tax and estate planning services, tailored to our valued clients. By way of introduction to these services, we offer our TAXBITES series of newsletters and we hope you find them valuable.

Private Investment Management – An investment option with tax advantages

In our last TAXBITES, we talked about the merits of an Individual Pension Plan. One of the advantages we discussed is the ability to deduct investment management fees if they are paid by the Professional Corporation. The key to this deductibility is that the investment management fees must be explicitly “paid” and not merely subtracted from the rate of return credited to your investment account. Let’s explore this concept further.
In the Canadian investment landscape, there are myriad choices an individual investor can make for the management of their holdings. The most popular choices, particularly for RRSPs, are Managed Funds, Index Funds and GICs.

Managed funds (Mutual Funds, Segregated Funds)

Although created in the early 1900s, this vehicle took off in popularity with the average investor in the 1980s. The retail Mutual Fund was created to solve the challenge of diversifying your investments when you only have small dollars to invest. Investors with a few thousand dollars could not adequately spread their savings over enough different vehicles, companies or asset classes to properly reduce risk. By creating a fund where many clients pool their money together, a professional manager can take a much larger pool of money and spread it over hundreds of stocks and bonds. The investor, in turn, owns a tiny fraction or “unit” of this fund and experiences gains and losses at the same fraction of the giant investment fund. In return for access to “instant diversification” and professional management, the investor pays the manager a fee that is deducted before crediting returns to the fund.

Index Funds

These are similar to managed funds, but with less management. Investors again pool their money to create a large fund. Instead of performing research to select the best securities for the fund, the manager purchases a static basket of companies. In Canada, the most popular versions of these funds will buy all of the stocks in the S&P/TSX 60. These are generally the 60 largest companies in Canada. The manager ignores whether these are the “best” 60 companies and simply maintains a position in all companies, good or bad. For this hands-off management, the fees tend to be much lower than Managed Funds. However, because both good and bad performing stocks are owned, the returns tend to be more volatile.

GIC’s

Banks and insurance companies borrow money from investors in two different ways. They issue Bonds and they issue GICs. Bonds are issued in very large dollar amounts ($millions) and are a promise to repay the amount borrowed after a specific term, while semi-annually paying a rate of interest. GIC’s offer a similar arrangement for the smaller-dollar investor – a fixed rate of interest with principal repayment at the end of a set term. Where bonds can be bought and re-sold on public markets throughout the term, GICs are generally non-transferable. Because of the smaller dominations, GICs tend to offer lower interest rates. The difference in interest rate between the larger domination Bonds and lower denomination GICs can be seen as a form of management fee charged to the retail investor.

While managed funds, index funds, and GIC’s are the most popular vehicles, they’re not for everybody. There comes a point where an investor has accumulated enough savings to no longer require the “pooled” concept; they have enough of their own money to be adequately diversified. Shedding the higher fees of the Managed Fund concept, these investors move up to Private Investment Management (PIM).

Private Investment Management

For typically less than half the fees of a Mutual Fund, an investor with significant investible assets can obtain professional management and proper diversification. Professional management tends to lower the volatility of the investment accounts and lower fees mean higher returns.
PIM clients hold their investments in an account with a professional custodian – TD Waterhouse, is an example – and authorize a separate Private Investment Counsellor to purchase individual securities in the account according to the client’s stated risk-tolerance. The Counsellor is paid a fee to manage the account rather than being compensated for each transaction. PIM clients tend to enjoy the transparency of seeing the individual companies in which they are invested rather than the obscurity that often comes from owning a Managed Fund.
And those fees, which can be less than half of Managed Accounts, may also be tax-deductible! For non-registered accounts, the fees, which are transparent and charged separately, are fully tax-deductible. This effectively reduces the fees even further on an after-tax basis. This is not the case for Managed Accounts.

How low are PIM fees? What are the minimums?

The fees and thresholds vary substantially between PIM firms. Fees usually start below 1.5% and decrease with larger account size. Some offer “all-in” pricing models while others may have some additional fees. We work with a firm that has a $300,000 threshold but many PIM firms require $1 million or more before they will open an account. Fees at the firm we recommend start at about 1.2% and drop to 1% at $1 million of invested assets.
As with all investments, there needs to be a good comfort level with the manager, the institution, the costs and the risks. But with many PIM options in the market place, investors with higher dollar amounts to invest should explore the savings and the tax advantages they bring.
Your Protect financial advisor would be happy to provide you with more information on all of these investment options, including Private Investment Management.

 

Todd Roberts, B.Com.

Vice President
Tel:
416-391-3764, ext. 233

Toll free: 1-866-919-3764

E-mail: todd.roberts@protect-ins.com

 

The views expressed in this commentary are those of Protect Insurance Agencies Inc. (Protect) at the date of publication, are subject to change without notice, and are not representrd to be error free. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific insurance products or investments, nor is it intended to provide tax, legal or accounting advice in general or specific to your circumstances. Buyers should review all documents relating to any insurance or investment carefully before making a decision and should ask their advisors for guidance based on their specific circumstances. Protect assumes no responsibility for how you use the information you obtain from this commentary.  E. &. O.E.

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