The federal and provincial governments introduced LSIFs in the 1980s to promote economic growth by encouraging Canadians to invest in small- to medium-sized companies.
LSIFs invest in companies developing new products or markets. These ventures can be risky, so the government offers tax credits as an incentive for investors and to offset the extra risk.
For example, in B.C., investors in LSIFs can receive a combined federal and provincial tax credit of 30%. On a $5,000 investment, the tax credit is $1,500.
Where to buy LSIFs
You can buy an LSIF from an investment firm or directly from the mutual fund company.
Warning: Ontario has been gradually phasing out its LSIF tax credit. By 2012-2013, the credit will be eliminated. You can still buy an LSIF, but Ontario’s decision has meant some funds and companies have performed poorly. Learn more about Ontario’s LSIF program.
3 main risks
Investments are speculative – LSIFs invest in riskier ventures. Many of these companies are small and unproven, and are in the early stages of developing new products or markets. There’s a good chance they could lose money or go out of business.
Your money is locked in for 8 years – If you sell early, you’ll lose any tax credits you claimed. You may also have to pay an early redemption fee.
Funds can suspend redemptions without notice – You may not be able to get your money out when you need it.
4 costs of LSIFs
Management fees – Like a mutual fund, your costs include fees for managing and operating the fund. This is called the management expense ratio (or MER). Most LSIFs charge a higher MER than mutual funds because they have higher research costs. The annual MER for equity mutual funds in Canada averages about 2.4%. Most LSIFs have an MER of 5% or more.
Performance fees – These fees reward LSIF managers for good performance. Different funds use different formulas. Some LSIFs pay a performance fee if the fund’s yearly return is higher than 6%, before costs. Others calculate the return after costs.
Sales commissions – These fees go to the salespeople who sell the LSIF to investors.
Early redemption fee – This fee could apply if you sell early.
Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca