Sector Funds: Tax-deffered compounding outside your RRSP - Fiscal Agents Money Management Newsletter

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The Companion Advisor: Mutual Funds
Sector Funds: Tax-deferred compounding outside your RRSP
The power of tax-deferred

A Companion Advisor Article

Compounding Financial experts agree on one thing. The great benefit of an RSP is not the immediate tax deduction for contributions--it's the tax-deferred compounding that really counts.

Sector funds give you tax-deferred compounding--like having a second RSP.

Long-term tax-deferred compounding is very powerful. Below we compare the value of a $10,000 investment compounded at 12% annually in two ways: (1) subject to 40% tax annually and (2) if tax is paid upon redemption.

If you held this sample investment for 30 years, your after-tax value would be $183,760 compared to $80,509 if the same investment were taxed annually.

As you can see, sector funds are very different funds. Generally, they invest in an underlying traditional mutual fund. Because a sector fund is structured as a corporation and not as a traditional mutual fund, you can switch among investments in underlying funds without triggering a capital gain. As long as your investment remains within the sector fund, your gains are tax-deferred. If you redeem sector fund units, however, you must report your gains or losses and pay any taxes owing.

Also, sector funds may pay dividends to investors from time to time which will reduce the tax-deferral advantage because you must include these dividends in computing your income for tax purposes.

The Strength of Diversity Because sector funds invest in other funds, they allow the utmost in diversification. You can often invest according to:

- Geography (e.g. Europe, Asia, Latin America, etc.)

- Investment Type (equities or short-term)

- Industry Sectors (e.g. health sciences, financial services, etc.)

- Management Style (asset allocation, fundamental value, sector rotation)

The Advantage to You

Sector funds are attractive to a broad spectrum of investors.

- If you buy and hold, your capital gains continue to compound year after year, tax-deferred.

- If you trade actively, you can switch funds according to market conditions as many times as you want--without paying tax on your capital gains.

- If you regularly re-balance your portfolio to meet your investment objectives, you can defer any capital gains taxes that may result from portfolio adjustments.

The power of tax-deferred compounding and the strength of diversity. It may be worthwhile to talk to your Fiscal Agents - financial adviser about tax-deferred sector funds.

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