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 December 28, 2022
After 20 years in tech sales, Duncan has been laid off and is turning to consulting. He figures he can bill about $125,000 a year on average. His wife Lorna, who is self-employed, earns more than $100,000 a year. Duncan is age 53, Lorna is 43. They have two children, ages 9 and 13.
Duncan hopes to retire from work completely in about three years, when he will be 56. Lorna wants to retire by 2030, when she will be 51.
“I’ve been pretty successful to date by most standards,” Duncan writes in an e-mail. He says he managed to save a fair sum by working hard and being sensible with money.
The pandemic caused Duncan to question the need to go back into the job market, he writes. By changing careers and becoming an independent consultant, he hopes to improve his family life. “I started a family late in life and my wife is 10 years my junior,” he writes. “This makes me anxious about the limited quality time I have with them.” He’s also concerned about “providing a solid financial foundation for them later in life, when I’m gone.”
Although Lorna makes a good living as an independent contractor, she has no workplace benefits or pension plan.
Can Duncan and Lorna afford to retire so early? Their retirement spending goal is $100,000 a year after tax. Duncan, a do-it-yourself investor, also wonders whether he should consider a more balanced investment portfolio.
We asked Matthew Ardrey, a financial planner and portfolio manager at TriDelta Financial in Toronto, to look at Duncan and Lorna’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
Duncan is wondering how much longer he needs to work given that he is 10 years older than Lorna, Mr. Ardrey says.
They are saving $10,000 a year to Lorna’s registered retirement savings plan and $22,500 to Duncan’s. They also make maximum contributions to their tax-free savings account. Any additional surpluses go to their savings account.
In the coming year, they plan to complete a $50,000 home renovation, which will be funded by their cash savings, the planner says. They also plan a large vacation each year with a cost of $10,000.
In 2027 and 2031, respectively, each of their children will be starting a four-year postsecondary degree and will likely be living away from home. The average cost in current-year dollars is $20,000 a year, Mr. Ardrey says. The registered education savings plan Duncan and Lorna have set up, plus an additional $20,000 in the children’s savings account, will pay for about 65 per cent of the cost. The remainder will come from the couple’s savings.
In addition to their Toronto home, Duncan and Lorna own two rental properties worth a total of $1.25-million with about $795,000 of mortgages on them. The properties are cash flow negative, which means they are costing more than they are bringing in, Mr. Ardrey notes. This causes concerns because the mortgages renew in 2024 and 2026, at which time the expected interest rate will be much higher than the 2.66 per cent they are paying now.
In retirement they plan to spend $100,000 a year, plus an additional $6,500 wintering in the United States with Lorna’s family. Their current lifestyle spending is about $105,000 a year. They plan to give each of their two children $200,000 toward a down payment for a house in 2033 and 2037.
In preparing his forecast, Mr. Ardrey assumes Duncan and Lorna begin collecting Canada Pension Plan and Old Age Security benefits at age 65. CPP is expected to be 70 per cent of maximum for both spouses owing to early retirement, he says. Inflation is assumed to be 3 per cent and life expectancy age 90.
Their current investment portfolio is 80 per cent stocks and 20 per cent cash. “This produces an expected future return of 5.05 per cent, but with significant volatility,” the planner says. As most of the portfolio is in direct stock holdings and low-cost exchange-traded funds, fees are negligible. “This portfolio is too high-risk given their proximity to retirement,” Mr. Ardrey says. “Thus, we assume they move to a balanced 60/40 portfolio, which reduces the future expected return to 4.57 per cent.”
Under these assumptions, their retirement spending goal fails, the planner says. They run short of funds by Lorna’s age 84.
“One of the ways we stress test a scenario is by using a computer program known as a Monte Carlo simulation,” the planner says. This introduces randomness to a number of factors, including returns. Under the Monte Carlo simulation, Duncan and Lorna’s probability of success is only 37 per cent.
“To heighten the chances of success, they could always spend less, save more, work longer or the one everyone wants to avoid, die early,” Mr. Ardrey says. If they want to avoid these choices, a better option is to improve their investment strategy. This would include liquidating their rental properties in retirement in favour of other investments that produce more income, especially given the expected higher cost of borrowing, he says.
As well, they should look to minimize cash holdings, increase their fixed-income allocation and include an allocation to some non-traditional asset classes such as privately traded real estate investment trusts, Mr. Ardrey says. These investments typically have little or no correlation to the equity and fixed-income markets. “Underlying assets of the REIT are an important consideration. I prefer those that focus on the residential multi-unit market or specific areas of growth like 5G infrastructure versus those who have more exposure to areas like retail,” he says.
By diversifying their portfolio and eliminating cash investments, he estimates they could achieve a 5.50-per-cent return, net of fees, and significantly reduce the volatility risk of the portfolio. As well, many private real estate investment trusts are tax-efficient, having distributions that are part or all return of capital, the planner says. “With this adjustment, the change in the Monte Carlo simulation is material, moving it up to a 70 per cent probability of success.”
There still is a statistical chance that the projection will fail. To increase the chance of success to more than 90 per cent, they would need to work about five years longer or cut their retirement spending by $1,000 a month, Mr. Ardrey says. “They’d also have to reduce the amount gifted to each child by half.”
Lorna and Duncan have some decisions to make, the planner says. They must decide whether it is more important to enjoy the life they want, including an early retirement, or to focus more on giving their children down-payment money and leaving a big estate.
The people: Duncan, 53; Lorna, 43; and their children, 9 and 13.
The problem: Can Lorna and Duncan afford to retire early and still live the lifestyle they want?
The plan: Make adjustments to their portfolio to lower risk and improve returns. Prepare to work longer or spend less. Be less generous with the children’s down-payment gifts.
The payoff: A clear idea of the tradeoffs they face.
Monthly net income: Variable.
Assets: Cash and short-term $350,000; his stocks $1,353,100; her stocks $485,220; children’s savings account $20,070; his TFSA $118,505; her TFSA $112,805; his RRSP $901,670; her RRSP $243,285; registered education savings plan $89,835; residence $1.5-million; investment properties $1.25-million. Total: $6.42-million.
Monthly outlays: Mortgage $2,565; property tax $460; water, sewer, garbage $110; home insurance $120; heat, electricity $200; garden $20; car lease $410; other transportation $400; groceries $800; clothing $20; gifts, charity $140; vacation, travel $1,000; dining, drinks, entertainment $520; personal care $20; club memberships $120; golf $50; sports, hobbies $250; subscriptions $25; other personal $200; health care $100; health, dental insurance $515; life insurance $320; cellphones $200; TV, internet $200; RRSPs $2,710; RESP $415; TFSAs $1,000. Total: $12,890
Liabilities: Residence mortgage $75,710; rental mortgages, $794,340. Total: $870,050
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Some details may be changed to protect the privacy of the persons profiled.
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