Sunday, 20 December 2015

Mutual Funds: What Are You Actually Paying?

What fees do mutual funds charge?

Mutual funds are still incredibly popular in the investment world, and I'm sure many of you have at least a portion of your investment portfolio in funds (I do). As of May 2017, there was $1,428 billion of assets under management in mutual funds. There's some hate against mutual funds in the finance community but, in my opinion, they can be a good option, especially for beginner investors or those who are not willing to put in the time researching other options themselves. 

Think of a mutual fund as a collection of other investments such as stocks and bonds. Most funds will have a specific mandate that they follow that will limit them to a specific risk tolerance or market sector; for example, you'll get funds that are based in Canadian equities, US small cap companies, corporate bonds, or dividend generating investments. The fund will be run by a fund manager who decides what to hold and when to buy and sell particular holdings. That expertise is what you're paying for, and I'm ok with that. Part of being a responsible investor is understanding how these fees work and ensuring you are getting your money worth. There are a couple of different fees you will be charged by a mutual fund; sales charges and MER' let's get into what those actually are. 

Sales Charges
There are a few different ways you can pay to buy a mutual fund and which option you choose will be determined you and your advisor. 

The first versions are front end (FE) or initial sales charge (ISC) funds. For these, you will pay your investment advisor a commission to purchase the fund for you; this can range anywhere from 0% to about 5%. FE funds would be used in accounts where you don't pay your advisor an additional management fee; they would get paid via the commission and the trailer fee (more to come on that). Feel free to negotiate this fee with your advisor but do keep in mind what sort of other work they do for you. If you are getting retirement or tax planning advice at no extra charge, then FE funds could very well be how you are paying for their services. 

Next up are back end or deferred sales charges (DSC) funds and, for these, you won't pay anything up front for the fund, but you will have to pay a penalty if you pull your money out of the fund too soon (in the 5-7% range). Usually, you have to keep your money in the fund for 5-7 years to avoid the penalty, but a lot of companies let you take out 10% of your holding free of charge each year and switch between funds in the same company over that same period. DSC funds are the black sheep of the mutual fund world, and many companies are eliminating them altogether. Other than potentially avoiding a commission charge, there is no benefit to investors in choosing DSC funds over FE funds...there's only downside with the locked-in component. If your advisor is recommending DSC funds, you should absolutely question the advice and potentially look elsewhere for help. 

There are also low load (LL) funds that are very similar to DSC funds (penalties to withdraw), but with shorter terms. Most LL funds will charge you about a 3% penalty and will fully mature after three years. Again, not an option I would necessarily recommend so make sure you understand the reasoning behind why your advisor would be suggesting. 

Finally, there are no load (NL) funds. These won't charge you any sales charges to buy or sell and also have lower MER's than the above alternatives. Sounds ideal right? There's a catch though. These are only offered in fee-based accounts where you would be paying a management fee directly to your advisor. 

For most mutual funds you will be able to buy the same fund by any of the above means. For example, you could buy Cdn Bond Fund-DSC, Cdn Bond Fund-FE, Cdn Bond Fund-LL, or Cdn Bond Fund-NL and they will all be the same except for the sales charge you pay (hold the same investments and be managed by the same person). 

Management and/or Operating Expenses (MER's)
The mutual fund also has certain expenses that they have to pay (salaries, bookkeeping, reporting, etc.) so they pull the cost of these expenses straight out of the fund's earnings. Usually, these charges will go unnoticed by the investor as they don't show up on your account statements. Instead, they just lower the rate of return of the fund. There has been a push for more transparency in the industry (especially regarding fees), so you will now receive what is called a 'Fund Facts' document prior to purchasing a mutual fund. The 'Fund Facts' will list information on the fund including current holdings, the risk level, and the associated fees. 

Most MER's are between 1% and 3%. This depends on the type of fund and how actively traded it is. For example, bond funds tend to be more conservative with less volatility, so there isn't as much trading done by the manager, and they would have a lower MER than a mutual fund with more stock holdings. Usually the more conservative a fund, the lower the MER. If a fund you hold is charging an MER of 2% and that fund had a rate of return of 9% for the year, the actual rate of return you would see after fees would be 7%. 

The majority of the MER goes to operating expenses for the fund, but there is also a trailer fee that is paid back to the advisor who sold the fund. Usually, the fee is between 0.25% and 1.25% and is kind of like a finders fee for bringing you in as a client for the mutual fund company. The trailer fee would be eliminated if you are buying the no load version of a fund and would be replaced by the management fee your advisor would charge you directly, however, the rest of the MER would still be charged. 

There's no escaping fees if you are investing in mutual funds but understanding what and how you're being charged can help you in determining the best options for your portfolio. 

What fees do mutual funds charge?

Tuesday, 15 December 2015

Government Pensions (CPP, OAS & GIS)

Canadian Government Pensions

Last week we talked about the basics of pensions that are provided by your employer so now we are going to focus on the government pensions that are available to you (us Canadians anyways). The most significant is usually the Canada Pension Plan but there is also Old Age Security and the Guaranteed Income Supplement that can help out retirees. 

Canada Pension Plan (CPP)
If you work in Canada you most likely contribute to CPP (one of those pesky deductions off your pay cheque) and that means you will be eligible to receive a CPP payment in retirement. The norm is to start receiving CPP at age 65 but you can also take a decreased pension as early as age 60 or an increased pension if you delay past age 65. In most circumstances it makes sense to start collecting CPP at whatever age you retire; the extra tax you would pay if you are still working (increased income) often cancels out any benefit taking it early. The penalty for taking your CPP early is increasing, so that's something to keep in mind; for 2015 it is (was) 0.58% per month prior to age 65 and for 2016 it will be 0.60%. 

The amount of CPP you will receive is dependent on how much you have contributed and how many years you have worked in Canada. Makes sense right? The longer you've worked and the more you've contributed the higher your CPP will be. Just to give you an idea, the maximum CPP payment for 2015 is $1,065/month and this does increase each year. There are however a couple of factors the CPP includes that may increase your CPP. The first is the 'General Drop-Out Provision'. What happens here is that some low (or no) earning years can be ignored to help boost your CPP amount. If you were a student, unemployed, etc. you can drop some or maybe all of those years so they won't have an impact. Probably the most common situation that would keep you out of the workforce for an extended period is having children, so CPP has a specific provision to deal with this. The 'Child-Rearing Provision' can be used if you stopped (or worked less) because you were the primary caregiver for your kid(s). The one big difference between the two provisions is that the drop-out happens automatically whereas the child-rearing has to be requested, so if it applies to you make sure you do that. 

Now that just focuses on the retirement pension but CPP also includes disability benefits and a survivor benefit. These will help to cover you if you have a disability that keeps you out of the workforce long-term or if your spouse passes away. For more information on CPP you can check out this site

Old Age Security (OAS)
Next up is OAS which can also play a pretty important role in the income of retirees. Unlike CPP, OAS is available to all legal Canadian residents and is dependent on how many years you have lived in Canada and not on contributions. You can apply to start receiving OAS at age 65. The age had been pushed back to 67 under the Harper government but that has since been reversed back to age 65. Check here for the details. 

To receive the maximum OAS amount you need to have lived in Canada for at least 40 years (after you turned 18) and have resided in Canada for the 10 years prior to applying. The current maximum OAS benefit is $569.95/month and this amount is reviewed quarterly and is indexed to rise with inflation. 

One thing to remember is that if you have a high income in retirement your OAS may be clawed back (or as the government likes to call it, OAS recovery/repayment). For 2015 the income threshold is $72,809 and this also increases with inflation and the clawback rate is 15%. This means that for every dollar over $72,809 you will have to pay back $0.15. If you have an income over $118,055 your OAS will be fully clawed back. This is important to keep in mind if you'll have a big pension in retirement, you will want to look at maybe pulling money out your RRSP's prior to age 65 and making use of income splitting. 

Guaranteed Income Supplement (GIS)
The final government pension that is available is the GIS but it is only for those with low income in retirement. The GIS is based on your annual income (if you are single) and on a combined income if you are married. For a single person your income has to be below $17,280 to be eligible. For more information on the income levels and payment amounts you can check the tables at the bottom of this page

Side-note: The Service Canada website has been pretty awful lately, so if you are having trouble opening the links provided above you may have to try back a little later; I promise the links are correct (at least as of the date this was posted). 

Canadian Government Pensions

Wednesday, 9 December 2015

The Basics on Workplace Pension Plans

Workplace pension plans

Pensions are kind of the golden ticket in retirement planning as they have such a huge impact on how much money will be coming in the door after you retire but not all pensions are created equal. Today I'm going to break down the basic kinds of pensions that may be offered through your employer. This doesn't include government pensions like CPP and OAS; we'll tackle those another day. 

Defined Benefit Pension Plans
DB plans are the real winners in the pension world, and when most people think of a pension, this is what they're thinking of. A DB pension will pay you a guaranteed monthly pension after you retire that will be based on your years of service, salary and a bunch of far more complicated calculations. This means that you will get a pension cheque every month after you retire until you die (depending on the option you choose your spouse may even still receive your pension payment after you die). This is the ultimate in security (guaranteed), and you would need to have a lot of money invested to come anywhere near the amount your pension will pay out. 

Let's look at a quick example. Say you receive a monthly pension of $2,500/month that will be paid out from when you retire at age 60 until you pass away at age 90. In this scenario you would get: $2500 x 12 months per year x 30 years = $900,000. 

Some defined benefit pensions also have indexing built into them. This means that they will increase over your retirement to either completely or partially keep up with inflation. As we're all aware, prices tend to go up over time (that's inflation) so $2,500 today will not have the same buying power as $2,500 in 20 years, that's what indexing tries to solve. A fully indexed, defined benefit pension plan is the best and safest option you can have in retirement, the problem is, not many jobs come with that benefit anymore because it's incredibly expensive for employers. Keep in mind though, if you do get a DB pension with your job, make sure you weigh that if you're considering a job switch. You may get a higher salary somewhere else, but that payment in retirement could be enough to make a lower salary worth sticking with. 

Defined Contribution Pension Plan
The other big option (and much more common these days) in pensions are DCPP's. These plans have both you and your employer contributing a portion of your salary into a retirement account that is similar to an RRSP but with some extra restrictions. The big difference between the two types of pensions is that the DB plan will pay you out a guaranteed amount until you die,  and the DCPP will provide you with money only until you run out. If you end up with $500,000 in your DCPP at retirement and you spend it all in the first 10 years of retirement, that money is goners, so you need to make sure you plan your withdrawals accordingly. 

There are a couple other factors of DCPP's that many people do like. You can usually move your funds out of the plan at retirement (and sometimes before). That gives you the chance to make your own investment decisions (just as you would a personal RRSP). Another thing is that if you die that account will remain with your estate and pass on to whoever you have listed as the beneficiary. Except for your spouse (if you choose a joint pension option), your DB pension will stop paying if you die. If you don't live that long after you start collecting your pension you wont receive that much money...of course, this is impossible to know. 

Now, when I say DCPP's go into an account similar to an RRSP this is true, but you do need to be aware of certain limitations. The accounts are usually called Locked-In RRSP's and they are exactly as they sound. Except for some exceptional situations (hardship or shortened life expectancy), you cannot pull any money out of the account until you are retired and even then there are yearly minimums and maximums. The government does this so you don't do what I said above and go out and spend the whole $500,000 (or whatever) in the first few years of retirement...they force you to be at least somewhat responsible. 

Group RRSP's
Now group RRSP plans aren't actually a type of pension, but since they are also often offered by employers, I thought I would include them here too. Similar to a DCPP, your employer would match a set amount of your own contributions to the RRSP. Many of these plans still have restrictions on moving the funds to a different place while you are still working with the company but would abide by the same rules as a regular RRSP after you retire. The limitations on withdrawals is not an issue with RRSP's as it is with DCPP's. 

Ok guys, those are the basics. Any type of pension is a great added benefit, and if it is offered with your company, you should definitely sign up. Do you have workplace benefits or are you on your own when it comes to saving for retirement? 

Workplace pension plans

Thursday, 3 December 2015

Estate Planning Basics

Creating an estate plan

No one ever likes to talk about death, but today we're doing it. It's not exactly a subject that comes up at the family dinner table every often, but it is a conversation that you need to have with your loved ones, just in case a tragic event strikes. It is always better to be overly prepared than be forced into a situation where you have to make life or death decisions with no background information. 

When you're young (and you know, invincible) the last thing on your mind is what would happen to your assets if you passed away. This is especially true when you may not have much in the way of assets, but that doesn't mean it's not important to plan for the future. You don't necessarily have to get your full estate plan in place if you don't have much in the way of assets and no children to make decisions for but there are some advantages of getting a head start. The one biggie is life insurance. The younger you are the cheaper your life insurance premiums will be. Learning about estate planning can also help you if you have ageing parents who might need a little nudge to get their affairs in order. If you already have your own children, you definitely need to start the process and get an estate plan in place. 

So what exactly is an estate plan and what do you need to get done to ensure you have a functioning one in place?  

The Will 
This is the big one, and you want (need) to make sure it is done properly. Sure you can buy a 'Write your own Will' kit off the internet but just don't ok? I really recommend having a lawyer take care of this for you, no matter how simple you think it might be. The last thing you want is for your family to be arguing over non-specific language in your will after you're gone, and this happens more often than you would think. No matter how close you think your children may be, conflicts over an estate happen, and the one way you can control things from the grave (ok, that's a little creepy) is by having a clear and concise Will. Yes, it's going to cost you to have a lawyer prepare your Will, but I promise you it is worth it in the long run. Your Will is where you are going to indicate who gets what of your assets (investments, property, and possessions) and also where you will appoint a guardian to any underage children. Have these conversations before you meet with a lawyer and make sure that people who are getting assigned a job are informed. Sure, that scene it 'Manchester by the Sea' where Casey Affleck finds out his brother chose him to take care of his son might have been funny in a dark and painful sort of way but that's a movie...not real life. Most estate lawyers will provide you with a questionnaire or worksheet to help you plan all things out before you actually meet. 

Enduring Power of Attorney 
It makes sense to get a Power of Attorney done while you are getting your Will done. An enduring POA will allow you to choose someone to make decisions about your finances and your property when you are no longer able to make such decisions yourself. Don't worry about hurting anyone's feelings here; you don't have to choose someone just because they are family. This is not an easy job for anyone (and it could potentially be long-term), so you are looking for someone who can function under stress and make the decisions you would make if you were able. 

Personal Directive (Living Will)
A personal directive is similar to a POA in that it gives someone the decision making power when you are no longer able, but the PD covers decisions regarding your health and personal well-being. This includes such things as medical treatment, where and how you will live, and what happens to your children. Often it makes sense to choose the same person for your POA and PD, but it doesn't have to be. You know your people so do what makes the most sense for your situation, and remember, you can always change your mind in the future. 

Life Insurance 
You will want to ensure your debts are covered and your loved ones can continue to live comfortably if you die suddenly and life insurance can be a major factor in accomplishing that. If you all your debts are paid up, and you already have enough assets saved up to ensure any potential beneficiaries are taken care of then insurance isn't as necessary. However, if that's not the case, then it becomes almost an essential. I would look at getting a term insurance policy for an amount that will cover the cost of any outstanding debts (mortgage, loans, credit cards, etc.), the cost of your funeral, and enough additional money for your spouse to live on and raise any children you may have. Slight side note here...when you are getting a mortgage your bank will try to sell you mortgage insurance; don't do it. It's actually kind of a scam, and I've talked about it more here. Term life insurance is the way to go. 

Ok, those are the big important documents that you want to make sure you have in place. Now I'm going to include a few extra tips that aren't exactly estate planning per se but will make things easier for your loved ones. 
  • Make sure your spouse is listed as an account holder on any accounts/policies you have, or is at least given permission to make decisions; for example, your spouse should be listed on your utility, phone, and cable bills to make any necessary changes if you're not around. If you don't have authorization on an account and your spouse has passed away you may have to jump through some ridiculous hoops to get answers and make any changes to the account. 
  • Keep a file with copies of your relevant documents (all of those we talked about above as well as bank and investment statements) and tell your loved ones where that is so it's easy for them to find. If you are the executor of an estate, it can be a real task trying to hunt down where the deceased had money. I like to keep things simple myself but that's not always the case, some people are all about not keeping all their eggs in one basket and have bank accounts and/or investment accounts at numerous different institutions. 
  • Make sure the beneficiaries listed in your will match up with the beneficiaries you have listed on your insurance and investment accounts to avoid any confusion and keep those beneficiaries updated! There are rules in place for this (life insurance trumps Will but Will trumps investment accounts), but it's an easy change to make and helps avoid any conflict. Imagine how you might feel if you think you're the listed beneficiary on a large RRSP account only to find out the Will specifies otherwise...
  • If you are lucky enough to have a pension, make sure you (and your spouse) know your pension options. When you are retiring, you will be most likely be given different options on how and when your pension is paid out which can include how much your spouse would receive in the event of your death and potential guarantees for set terms. You might get a higher monthly amount if you choose an option where your spouse gets a reduced pension with no guarantee after your death but that might not make sense in the long run. Taking the slightly smaller pension now could save your spouse from suffering money troubles in the future.
  • So much of our lives are online now that it can be helpful to have a record of usernames/passwords that can be accessed to shut down online services. I'm sure if you take a look through your credit card statement you likely have a few online services that you are paying for (Netflix, Spotify, etc.) and those would all need to be cancelled. There are also things like email accounts, online banking, and social media accounts that may need to be accessed for monitoring or to shut them down. 
  • If you have pets, you'll want to make sure you have someone who is willing to take care of them. You can even set aside a portion of your assets to whoever gets the job to make sure your furry friends are given all the spoiling they deserve. 
  • Do you want to be an organ donor? If so you'll want to make sure you've discussed this with your family, so they have a heads up. Then you can sign the back of your Alberta Health Care Card (if you live here), register online, or register the next time you get your driver's license renewed at a registry. 
There you have it. Hopefully, you're now ready to get your estate plan in place and make sure your loved ones do the same thing. As always, feel free to post any questions down below. 

Creating an estate plan