ROB CARRICKThe Globe and MailPublished Friday, Feb. 01 2013, 7:38 PM ESTLast updated Friday, Feb. 01 2013, 7:38 PM EST5 comments 6231 Print /License AAOne of the benefits of saving aggressively for retirement is how easy your investing decisions can be when you stop working.Retirement planner Daryl Diamond uses a strategy that basically amounts to putting some or all of your retirement savings into a fixed monthly payout mutual fund and then living off the income flow without touching your principal or stressing about the markets.MORE RELATED TO THIS STORYROB CARRICK Pay your mortgage and save too? Here's a formula to build your wealthROB CARRICK The rainy day debate: Contribute to your RRSP or pay off debt?PORTFOLIO STRATEGY Lessons from the market's defensive all-star stocks 60-SECOND RRSP TIPSVideo: Forget RRSPs and pay down your mortgage 60-SECOND RRSP TIPVideo: Invest in your RRSP like a pension fund 60-SECOND RRSP TIPVideo: How to get out of the RRSP season rat race“Although it’s not guaranteed, historically this has been a pretty reliable and sustainable way to deliver income,” Mr. Diamond said. “You don’t have to get up and see what the stock market is doing in the morning because it’s not based on the value of your account.”When you’re investing in your preretirement years, your main goal is to maximize returns subject to limits imposed by age and risk tolerance. Once retired, the objective shifts to a large extent from growth to generating income from your investments.One option for deriving income from investments is to use a systematic withdrawal plan, where you slowly and gradually sell your holdings to fund your income needs. The problem with doing is that you may be forced to sell funds or stocks when they’re way down in price. When the markets rise, you’ll have less money to benefit from the turnaround.Mr. Diamond’s fixed payout strategy turns your retirement savings into an income-producing engine. You live off the income flow and leave your principal alone. What your investment is worth at any given moment is of no practical concern.The more you save for retirement, the more plausible it is that you’ll be able to live off the flow of income and not touch your principal. Of course, you can live primarily off income and sell investments periodically if required.The sort of monthly income funds used by Mr. Diamond are available by the hundreds in the mutual fund and exchange-traded fund worlds. These funds typically hold a mix of dividend stocks, government, corporate and high-yield bonds and, sometimes, preferred shares. In taxable accounts, the cash distributed every month may include a mix of interest income, dividends, return of capital and capital gains.It would be more tax-efficient in non-registered accounts to hold just dividend-paying stocks. But the point of monthly income funds is to create an income flow from a diversified portfolio suited to all types of market conditions. In any case, a monthly income fund outside a registered plan will result in less tax owing than a bond or term deposit.Even with bond and cash holdings that typically account for 40 to 50 per cent of the portfolio, monthly income funds can produce yields far in excess of what individual bonds and GICs offer. Mr. Diamond strongly believes that yields of 5 to 5.5 per cent are sustainable in today’s environment.Yield in this case is based on the past 12 monthly payouts expressed as a percentage of the net asset value of the fund, or NAV. Let’s take CI Signature High Income, one of the four monthly income funds used by Mr. Diamond, as an example. It pays 7 cents of income every month for every unit you own. The recent unit price was $14.42, which means a yield of 5.8 per cent.This yield figure is only relevant if you can count on the fund to keep paying out income at the same rate as it did in the past. Mr. Diamond stressed that there are no guarantees, but CI Signature High Income has not paid less than 7 cents a unit each month since the beginning of 2008, before the financial crisis began.Sustainability of the monthly payout is the top consideration in selecting a monthly income fund. As well as looking at whether the payout has ever been cut, Mr. Diamond considers the extent to which a return of capital is present in the distributions.Return of capital refers to cash over and above the taxable income generated by the investments in a fund. Each return of capital payment has the effect of lowering the cost that you will use at some point in the future to calculate your capital gain (or loss) when you sell your investment.There are structural reasons why monthly income fund distributions typically include a small return of capital, none of which should be a concern. Be much more cautious of funds that use a return of capital to pump up monthly payouts beyond what the underlying flow of bonds and interest justify. Worst case, a fund in this situation will start declining in value and cut the monthly payout to a more sustainable level.The mutual funds used by Mr. Diamond have managed to increase their unit price while sustaining their payouts. CI Signature High Income has a 10-year annualized return of 9.7 per cent, a little more than double the average for its competitors in the global neutral balanced category.Monthly income funds are classified by whether their holdings are tilted to stocks over bonds, and whether they mainly hold securities issued in Canada or take a global approach. The categories where you’ll typically find monthly income funds include Canadian neutral and equity balanced and global neutral and equity balanced.To compare monthly income funds, start by using the fund profiles available on Globeinvestor.com. Scroll to the bottom of a profile and you’ll find the fund’s monthly payouts over the past 18 months or so. Divide the latest 12-month trailing total distribution by the recent unit price and multiply by 100 to get the yield on an after-fee basis.Prefer lower-cost ETFs to mutual funds? There are a few diversified monthly pay funds to consider, including the BMO Monthly Income ETF (ZMI) and the iShares Diversified Monthly Income Fund (XTR).Both of these funds hold stocks and bonds in a mix that is rebalanced – on a quarterly basis for the iShares fund and semi-annually for the BMO fund. If you check the monthly payouts for these ETFs, the iShares product has been the most consistent in providing level payouts in the past couple of years.The stock markets have been strong recently, and that makes systematic withdrawal plans look better than they did a few years ago. Mr. Diamond said that if you can stand the ups and downs, a systematic plan can work as well as his fixed payout strategy. “That’s why I don’t say this approach is better,” he said. “I say it’s more comfortable.”The Fixed Payout Approach to Retirement IncomeHere are four monthly income mutual funds that retirement planner Daryl Diamond uses to generate a flow of retirement income for clients FundAssets($-mil)MER(%)UnitPrice ($)Mnthpay-out(¢)Yld(%)1-yr% rtn3-yr% rtn5-yr% rtnCI Signature High Income4,5201.614.4275.8311.610.56.7CI Signature Diversified Yield1,5902.3410.4355.7512.36.9n/aDynamic Strategic Yield5,1142.2814.015.54.695.38.6n/aDynamic Alternative Yield3972.4910.525.56.275.9n/an/aThe Mechanics of the Fixed Payout StrategyInvestment$500,000Unit value of fund$10Units bought50,000Monthly payout per unit4.5 centsMonthly income$2,250Annual income$27,000Effective yield5.40%-----------------------------------------------------Next week: The mistakes that come up over and over in the investment accounts we look at for Portfolio Checkup.Could you use a second opinion on your investments?We’re looking for investors for our online video series Portfolio Checkup, where an investment adviser and I offer informal feedback on portfolios submitted by Globe readers. We’d love to hear from you ... whether you’ve just started investing, you’re well established as an investor, or if you retired long ago and want some feedback on how you’re doing. Small portfolios are welcome, anonymity is assured.Apply here. For more personal finance coverage, follow me on Twitter (@rcarrick) and Facebook (robcarrickfinance)
