Cost Avoidance: The Indirect Dividend

Earlier this year I was helping my brother out with his financial planning, and one key element of the planning was to cut expenses. Cutting expenses is an important factor of any planning session, since any reduction in expenses boosts your disposable income by an identical amount: save $5.00, and you suddenly have $5.00 to redeploy elsewhere. At the time, he was paying $14.95/month in banking fees at a major Canadian bank, which equates to $179.40/year. When I asked him why he paid the fees, he really didn’t have an answer. Like many individuals, he took fees as a given–albeit a horrible one–and paid them every month. With some nudging, we managed to move all of his accounts to Tangerine, and he now has an extra $14.95 every month in his pocket. By the way, if you decide to open up your own account at Tangerine, please use my referral key: 16176076S1 .

Of course, it is not always possible to move all of your banking. I have the lion’s share of my accounts at Tangerine, however I also have an account at BMO because my mortgage is with them, I have a US Dollar Chequing account there, and I use BMO InvestorLine as my discount brokerage. Having an account there just makes things easier. But, even having an account, there are ways to avoid the monthly fees. For my own plan, if I keep a minimum balance of $2,500 in the account, the fees are waived.

Now, I gave that bit of background, because Bank of Montreal is increasing the minimum balance you require to waive fees as of December 1, 2016. Here is a snaphot (as of November 29, 2016) of the proposed fee increases:

Plan Current minimum balance New minimum balance Difference $ Difference %
Practical $1,500 $2,000 +$500 +33%
Plus $2,500 $3,000 +$500 +20%
Performance $3,500 $4,000 +$500 +14%
Premium $5,000 $6,000 +$1,000 +20%

As with everything, the need to pay for fees is all about opportunity cost. As a consumer, I have two choices:

  1. Pay a monthly fee, and use the minimum balance as I see fit.
  2. Do not pay a monthly fee, and lock up the minimum balance with BMO.

Let’s look at the annual banking fees, relative to the minimum balance to avoid paying those fees:

Plan Monthly Fee Annual Fee Minimum Balance (Old) Cost Yield (Old) Minimum Balance (New) Cost Yield (New)
Practical $4.00 $48.00 $1,500 3.2% $2,000 2.4%
Plus $10.95 $131.40 $2,500 5.3% $3,000 4.4%
Performance $14.95 $179.40 $3,500 5.1% $4,000 4.5%
Premium $30.00 $360.00 $5,000 7.2% $6,000 6.0%

In the above, the Cost Yield column represents the percentage cost based on the minimum balance, to avoid paying the fees. So, for the Plus Plan, by keeping $2,500 in the account, I am avoiding $131.40 in fees per year, or 5.3% of the locked in money. Put another way: if I can find an investment that pays me at least 5.3%, I would be better off taking the $2,500, investing it in the investment, and using the proceeds to pay off the monthly fees. However, that 5.3% doesn’t take into account taxes. My marginal tax rate on dividends is 25.38% according to the tables on taxtips.ca, so in reality I need to find an investment that yields at least 7.0% (since 7.0%, less 25.38% taxes, would yield me 5.3%).

Now, years ago when I was faced this decision, it was hard to find an investment that would guarantee me 7.0% return (with an acceptable level of risk). The other wrinkle was that many ETFs or companies pay dividends quarterly, which means the income stream from the investment would be “lumpy” relative to the frequency of payments. But with the increase in BMO’s minimum balance, things change. Here are the updated tables using the December 1, 2016, minimum balances:

Plan Monthly Fee Annual Fee Minimum Balance (new) Cost Yield (new) After Tax Cost Yield (new)
Practical $4.00 $48.00 $2,000 2.4% 3.2%
Plus $10.95 $131.40 $3,000 4.4% 5.9%
Performance $14.95 $179.40 $4,000 4.5% 6.0%
Premium $30.00 $360.00 $6,000 6.0% 8.0%

My specific plan is the Plus plan, so I now have two choices: find an investment which gives me a guaranteed 5.9% return on $3,000 (which would give me $177.00, or $132.07 after taxes), or keep $3,000 locked at BMO, and avoid $131.40 in annual fees. Given that this $3,000 is a good place to stash emergency funds, and I wish to preserve safety of principal, at this point I feel it is still safer to keep the “ransom money” with BMO to avoid the fee. It is because of the savings that I call this the “indirect dividend”: I can either claim a dividend by investing the capital, or I can save the fee by locking the money away. Either way, I am “making” money off of locking away a fixed amount of capital.

Of course, there are ways to improve the above analysis. For one, if I purchased the shares in my TFSA, then there would be no tax implications, so I could focus on the Cost Yield, not the After Tax Cost Yield. Another possibility is preferred shares, which I spoke of in an earlier post. Over the next few weeks I will continue this analysis to see if there is a better way to obtain overall higher returns.

Onwards and upwards!