Tax Refund Finally Applied to Loan

Our tax refunds have finally arrived. It took over a month but that’s to be expected since we filed in April and filed paper returns (printed out from software of course). Over $4700 for the two of us. I have transferred the entire amount against the principal of our student loan. That makes a small dint in the loan but it will reduce our interest payments by about $20 per month. That is not huge, but that is $20 per month for many years to come, not just this year. My wife will also be receiving a one-time retroactive hiring bonus of on the order of $4500 so that is another $20/month savings on interest and next year we can get another $20/month from another tax refund. It will feel good to lower those monthly payments, leaving more room in our monthly cash flow for something like a mortgage payment in the future.

Currently we are just paying interest on the student loan every month. The reason is that our monthly cash flow is pretty tight now. All our money is going somewhere, whether it be RRSP and savings and the amount of disposable cash we have available is very limited. Rather than using the one-time debt payments to lower our interest payments and thus increase the amount of principal paid down every month (ie. constant monthly payments) thus shortening the amortization period, we have decided to take the $20/month savings and we will allocate that to one of our ING savings accounts. Ideally, if we could afford it, I would love to be able to pay interest and principal on the loan every month but it just cannot be done right now. Maximizing our RRSPs is our #1 concern, and I think that is the right thing to do as I expect the return in my RRSP to exceed the interest rate on the loan and secondly, the tax refund every year can be applied towards the loan’s principal anyways.

Has Miller’s fund outgrown his touch?

Has Miller’s fund outgrown his touch? discusses whether or not Bill Miller can continue to beat the S&P 500 for much longer. Bill Miller is investment manager for Legg Mason Value Trust. I recently purchased shares in CI Value Trust (Value Trust’s Canadian dollar equivalent) and currently it makes up my entire US portfolio.

. . . don’t be surprised if the fund hits head winds. It barely beat the S&P 500 last year, nosing it by less than a percentage point. And Value Trust trailed the S&P 500 for the first quarter, falling slightly while the index gained 4 percent.

Miller himself notes that the 15-year beating-the-S&P record is just “a fortunate accident of the calendar,”:

he added, noting that there would be no 15-year streak if the investment year ended in any month but December; in some years, Value Trust trailed the index in the 12 months ending in January, February and so forth.

The author Jay Hancok argues (briefly) that it would benefit current investors if the fund was closed up to new investors:

Is it time to close Legg Mason’s flagship mutual fund, Value Trust, to new investors? A good argument can be made that the answer, at least for current investors, is yes.

But Legg Mason has no plans of closing it up just yet:

Its money-management team “believes the fund can comfortably manage substantially greater assets than those presently under management,” says Miller in his statement to me. Value Trust’s low turnover will help.

Miller himself pointed out that:

many successful “managed” (non-index) funds are bigger. Fidelity Investments’ Contrafund had $65 billion in assets last month when it announced that it would bar new investors, to focus on working for existing shareholders.

The author argues that “the more S&P 500 stock that Value Trust absorbs, the harder it’s going to be for Value Trust to outperform the S&P 500.” This is less of a problem for Bill Miller, however, who “makes big, bold bets on relatively few stocks. At the end of last year – the most recent information available – just 10 stocks made up 45 percent of Value Trust’s holdings.”

Split Shares: Why Not Buy Both?

This is the last article concerning split shares. Why did I write 3 articles? Well it started out as one but it was just too long. The other reason is because I found there wasn’t much information on the web. There were the few articles I found, but it took me a long time to find those, and some of them were not even available from the source, I had to use Google’s cache to view them.

This last article asks the question, “Why not buy both?” Well, the answer is simple. If you bought both that would be no different than buying the common stock in the trust’s underlying portfolio. But you would be paying annual fees for the management of the split shares/split trust (see Split Shares: the Downside for more information about fees).

Let’s see an example. Say a split share was set up and it owned common shares in ABC Corp. The split trust sold 50% of their assets as preferred shares and 50% of their assets as capital shares. If ABC Corp paid a dividend of 3% annually, the preferred split share will pay 6% (3%/0.5 = 6%). You get the dividend from the equivalent amount of common stock your preferred share is invested in, plus the forfeited dividend from the capital shares. If the common stock rises 3%, the capital share will go up 6% (3%/0.5 = 6%). So if I bought either the preferred share or the capital share I will get a 6% total return (capital gain + dividend). If I buy both the capital shares and the preferred shares I still get a 6% total return, the exact same return I would get if I had bought shares in ABC Corp. directly (see above, I mentioned that ABC Corp. paid a dividend of 3% and it’s stock went up by 3%); however, I will be paying about 1% in managment fees (as an example), so that will reduce my return to 5%.

Some articles online provide further proof that buying both the capital shares and the preferred shares makes no sense. From an article previously available here but now no longer availablel anywhere online:

Now, as to how you would use either of these in a portfolio, the answer may be obvious by now. First, you would buy either the preferred shares or the capital shares, but not both – if you wanted both you could just buy the XIUs. Second, you would hold either outside an RRSP to reap the tax benefits, unless you were using the capital shares to speculate within an RRSP.
But most of all, you’d buy the preferred shares if you needed to supplement your income, and your tax situation made dividend income attractive relative to interest income. Alternatively, you’d buy the capital shares if you didn’t need income and needed enhanced tax-deferred capital gains. So it really comes down to your investment objectives: do you need income, or gains, or both? [emphais mine]

More from Money Digest:

Stripped common investments take dividend-paying stocks and split them into two parts: capital and dividend. Those who buy the capital part benefit from capital gains, while those who buy the dividend part benefit from dividends and any increases in dividends over time. . . To reduce the risk, many split share corporations buy a basket of dividend-paying stocks. An example of a stripped common is Can-Banc, traded on the Toronto Stock Exchange. Can-Banc represents shares in the five largest Canadian banks. You can buy either the dividend part (check the dividend yields with your broker before investing) or the capital gains part (which entitles you to participate in capital gains should these bank stocks appreciate).

The reason I investigated this is because my parents are invested in both the capital and preferred shares of the Top 10 Split Trust, a split trust that invests in common shares of the 6 largest banks and 4 largest insurance companies in Canada. Buying both is equivalent to buying the common stocks themselves in the underlying portfolio. Except when you buy the common shares themselves instead, you don’t have to pay the extra fees imposed by the company managing the trust. If you really want income buy the preferred shares only, not the capital shares as well. Especially with a potential bear market looming, the capital part of the split shares could tumble a lot.

Or just buy the the S&P/TSX Capped Financials Index through the iUnits XFN index. The 6 big banks make up over 70% of that index (so you’ll get a similar return to banks stocks in the Top 10 Split Shares, but with less risk). You’ll also pay less in MER (0.55% for the ETF vs. at least 1% for the split shares). Or just get the iUnits S&P/TSX 60 index through the XIU ETF which has a large financial component.

Their financial advisor is seriously out to lunch. At first I could not believe that he had invested them in both the capital and preferred shares of the split trusts, but he has. He is either: a) afraid to buy banks’ common stock, b) has never heard of XFN, XIU, or has a fear of indexes, c) doesn’t understand how split shares work, d) doesn’t care about cost and MERs (like the 1% MER on the split shares). I really hope they get burned in the next bear market just like they did with Nortel so they can finally leave this guy and his crappy advice for good.