The dangers of bond funds

Could investors be risking their retirement savings by investing in fixed-income securities?

The dangers of bond funds
While it is a must for investors to include fixed-income securities in their portfolio to ensure a steady stream of income, they could actually be risking their retirement savings by investing in bond funds.

In an interview with BNN, industry expert Dale Jackson explained how advisors satisfy investors’ need for fixed income with bond funds. Citing figures from Globefund, Jackson said this has not worked out so well given the dismal returns of fixed-income funds in the recent years.

In fact, average Canadian fixed-income fund has lost 2.6% over the past year. Looking on a five-year period, the average fixed-income fund has recorded a measly return of 1.5% annually.

"The culprit is fees, which could be as high as 3% annually. Without the fee, also called a management expense ratio (MER), most money-losing funds would have been in the black," Jackson stated.

He added that the reason why advisors prefer not to put their clients' money in guaranteed investment certificate (GIC) is the commission that they are getting.

"Typically 1% of that MER compensates the advisory firm as a commission. Let’s say you have a one million dollar portfolio and half of that is in a fixed income fund; that’s $5,000 each year out of your portfolio," Jackson explained.

While the new disclosure rules in CRM2 requires the dollar amount to be disclosed to clients, there are some twists helping advisors get over this hurdle.

For starters, the highest-fee bond funds are actually segregated funds and can be considered as insurance products wrapped in a mutual fund. This means that such funds are exempted from the CRM2 disclosure rules, allowing advisors to hide the dollar amount from their clients.

"To further muddy the waters, many investment advisors that recommend mutual funds are actually salespeople who are only qualified to sell mutual funds," Jackson said.

In conclusion, he encouraged investors to ask their advisors about bond funds and to seek ways on how to put their money in real fixed-income products with lower fees.

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