The dream of many people as they approach retirement age is to derive a safe and steady monthly income from their savings. One fund that seems to fit the bill is the popular BMO Monthly Income Fund that holds nearly $5 billion. However, investors may be in for a nasty surprise.
Let’s start with the positives. This fund has a very nice looking performance chart. Apart from the blip around the end of 2008, it has been on a steady uphill climb. Another great thing is that it has paid a steady monthly distribution of 6 cents per unit per month since the beginning of 2002.
So, what’s not to like? Many people would be surprised to learn that the unit price for this fund has dropped from $9.63 in January 2002 to $7.65 on 2012 March 8. How is this possible? What happened to the nice chart that mostly went up? Well, charts like this assume that distributions are reinvested. If you spend the monthly income, your remaining money does not follow this nice chart. I wonder how many investors mentally double-count the distributions.
What’s worse is that there has been a total of 24% inflation since January of 2002. Overall, the purchasing power of an investment in 2002 has dropped 36%. With the fund yield now at 9.4%, if the distributions stay the same, it is all but certain that investors’ principal will keep dropping at an ever increasing pace. The alternative is to reduce the monthly distributions. Either outcome would be an unwelcome shock to naive investors.
Even though this fund has a respectable 10-year return of 5.58% per year, the monthly distributions have been more than the returns. It is reasonable for people to dip into their principal as they approach end of life, but this should be carefully planned. Naive investors who use this fund from too young an age without understanding the erosion of principal may be in for a shock.