Below you will find a real life case study of a couple who is looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor & Portfolio Manager, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.
Special to The Globe and Mail
Published July 10, 2022
In their early 50s, with well-paying executive jobs, Leo and Linda want to sell their two-bedroom Toronto townhouse and buy a larger one, which would mean taking on substantial new mortgage debt.
They have no children “and are in the sweet spot of our respective careers,” Leo writes in an e-mail. He grosses $200,000 a year while she makes $125,000. Their existing townhouse is valued at $800,000 with a mortgage outstanding of $180,000 that they plan to pay off in four years. They have some savings but no work pensions.
“Can we afford to upsize our house and still hit our retirement goals?” Leo asks. “Is it advisable to carry mortgage debt into retirement?”
Leo plans to retire from work at age 67, Linda at 65. They plan to travel extensively for the first few years. Their retirement spending goal is $120,000 a year. “This covers our typical living and spending patterns and would provide a sleep-at-night factor,” Leo writes.
We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Leo and Linda’s situation. Mr. Ardrey holds the certified financial planner (CFP), advanced registered financial planner (RFP) and chartered investment manager (CIM) designations.
What the expert says
“First, we looked at a base case scenario where they did not buy a larger home,” Mr. Ardrey says. Each month, they save $2,000 to Leo’s RRSP and $1,400 to Linda’s. They save another $1,000 a month to Leo’s tax-free savings account. Each year, they have a surplus that also goes to savings. They spend about $9,500 a month on their lifestyle, plus another $3,400 on accelerated mortgage payments.
“In this scenario, we first assume from their surplus that they maximize their RRSPs,” the planner says. “Being in high tax brackets, this makes sense for their retirement.” The remaining surplus is assumed to be split between each of their TFSAs.
By 2026, Leo’s TFSA is maximized and by 2028, so is Linda’s, Mr. Ardrey says. They continue to make maximum annual TFSA contributions and any additional surplus is saved in a joint non-registered investment account.
Leo and Linda both spent part of their lives working abroad so they will have a slight reduction in their Old Age Security and Canada Pension Plan entitlements. Some of the CPP benefits may be offset by other social security agreements.
Leo and Linda went into the recent tumble in financial markets fully invested in stocks. They have since pared their holdings to 60 per cent with the balance in cash. They intend to rebuild their stock portfolio in time. They’ve asked the planner to assume they are 100 per cent in stocks going forward while they are working.
“Though I did use their assumption, I do have concerns with them liquidating a substantial part of their portfolio during a downturn,” he says. “I feel that their asset mix may not have been appropriate for their risk tolerance.” Indeed, “history has shown us that one of the worst things you can do for your returns is to exit when the market goes down. Not only do you crystalize your losses, but you also often miss out on a good part of the market recovery.”
In preparing his forecast, Mr. Ardrey assumes Leo and Linda shift from 100 per cent in equities to a balanced portfolio of 60 per cent stocks and 40 per cent bonds when they retire. He assumes they live to age 95 and the inflation rate averages 3 per cent. They earn 6.01 per cent on their investment while they are working and 4.74 per cent after they have retired. Total assets at Leo’s age 65 are estimated to be $3.1-million in future dollars.
“Under these assumptions, they do not meet their spending goal,” the planner says. Leo runs into a shortfall at age 92. “When we run the Monte Carlo simulation, the result is only a 38-per-cent probability of success.” (A Monte Carlo simulation is a computer program that tests a forecast against a number of random factors.) For a plan to be considered likely to succeed, it must have at least a 90-per-cent success rate.
Leo and Linda could benefit by further diversifying their portfolio, and potentially increasing their returns, by adding exposure to non-traditional asset classes such as private real estate funds that are not correlated to the stock market, Mr. Ardrey says. As well, many private real estate investments are tax efficient because they have distributions that are part or all return of capital, he adds.
Real estate investment trusts that invest in a large, diversified residential portfolio, or perhaps specific areas such as wireless network infrastructure, are preferable to ones that have a large exposure to retail, the planner says.
For Linda and Leo to reach the likely to succeed range, they will need to not only improve their investment returns, but also reduce their spending in retirement to 90 per cent of their target; that is, from $10,000 a month to $9,000, “which is not unrealistic.”
In the second scenario, the planner looks at what would happen if Leo and Linda sell their current home and buy a larger one for $1.5-million. They would need to take on a mortgage of about $870,000.
“It’s not surprising that the larger home purchase further impairs their ability to retire as planned.” They face their first shortfall at Leo’s age 81. The Monte Carlo simulation shows only a 6-per-cent probability of success.
To reach the likely area in the Monte Carlo simulation, they would need to improve their investment returns and also reduce their retirement spending to 60 per cent of their target, the planner says. This would be a material change in their lifestyle. “Linda and Leo must decide what is more important to them, a larger home or a larger lifestyle.”
Unfortunately, there is no magic bullet when it comes to retirement planning, Mr. Ardrey says. “If the plan is not working, we have to look to higher returns, an increase in the amount and duration of savings or a reduction in spending.”
With the increasing cost of housing in Canada’s major cities, the decision facing Leo and Linda is the one facing many Canadians, the planner says: their house or their lifestyle.
The people: Leo, 55, and Linda, 52
The problem: Can they afford to buy a bigger house without jeopardizing their retirement spending goal?
The plan: Give up the idea of upsizing and taking on debt. Take steps to improve investment returns and lower expectations for retirement spending from $10,000 a month to $9,000.
The payoff: Understanding their financial limitations, which will help them feel more satisfied with what they have.
Monthly net income: $19,870
Assets: Bank account $30,000; his TFSA $13,000; her TFSA $1,000; his RRSP $225,000; her RRSP $300,000; residence $800,000. Total: $1.37-million
Monthly outlays: Mortgage $3,400; property tax $250; home insurance $50; electricity, heat $250; maintenance $1,050; transportation $600; groceries $1,300; clothing $300; car loan $700; vacation, travel $1,200; dining out $1,000; entertainment $1,000; other personal $1,000; health care $225; health, disability insurance $250; communications $350; RRSPs $3,400; RESP for niece and nephew $350; TFSAs $1,000. Total: $17,675
Liabilities: Mortgage $180,000 at 3.17 per cent; car loan zero per cent $9,000. Total: $189,000
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Some details may be changed to protect the privacy of the persons profiled.