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FINANCIAL FACELIFT: Ed and Patti, both 58, have defined benefit pensions. But without a handle on what they spend, can they afford to retire early?

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March 17, 2023 , , ,

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.

gam-masthead
Written by: Dianne Maley
Special to The Globe and Mail
Published February 17, 2023

Ed and Patti are both 58 and itching to retire from their well-paying jobs. Ed works in education and Patti at a government agency, and their combined salaries total $204,000. Both have pensions indexed to inflation.

“I plan to retire on my 60th birthday in 2024,” Patti writes in an e-mail. Ed hopes to quit in 2027 when he turns 63. However, they plan to work part-time until they begin getting government benefits at age 65, although they’d prefer not to. Their short-term goal is to travel, heading to Europe in the fall and to a hot climate in winter.

They want to stay in their Maritime home as long as they can – then leave it to their two children, now in their late 20s. Their retirement spending goal is $80,000 a year after tax.

We asked Matthew Ardrey, a financial planner and portfolio manager at TriDelta Financial in Toronto, to look at Ed and Patti’s situation. Mr. Ardrey holds the certified financial planner (CFP) and the advanced registered financial planner (RFP) designations.

What the expert says

“Patti and Ed are within striking distance of their retirement, but before they finalize their decision, they want to ensure that they will have the necessary resources in place to make their dreams a reality,” Mr. Ardrey says. Their defined-benefit pension plans are “a luxury today,” the planner says. Many employers no longer offer DB plans, turning instead to defined-contribution plans, he notes. Patti will receive a pension of $27,600 per year, plus a bridge benefit – a payment provided from date of retirement until 65 – of $7,150 per year. Ed will receive a pension of $18,750 per year. All pension figures will be indexed to inflation.

After Ed retires at 63 and Patti at 60, they will work part-time till they turn 65, earning $12,000 per year each.

Their Canada Pension Plan benefits will be about 75 per cent of the maximum. When they are fully retired, they will start taking CPP along with maximum Old Age Security (subject to any OAS clawback). Inflation is assumed to be 3 per cent a year and their life expectancy is assumed to be age 90.

Patti and Ed have two low-interest mortgages, one of which comes due in 2025 and the other in 2026. At the current rate of payment, mortgage one will be retired in 2028 and mortgage two in 2031.

A major concern is the current budget, the planner says. Patti and Ed say they earn $9,745 per month net, but their net income is actually much higher – $12,430 a month. “There is nearly $2,700 each month that is not accounted for. This is a substantial difference.”

Using simple math, from the information they provided, their gross income is $17,008 a month. Subtracting income tax, CPP and EI contributions of $4,635 leaves net income of $12,373 a month. Their spending and savings total $9,745 a month, leaving a surplus of $2,619 a month unaccounted for, the planner says.

“With retirement planned right around the corner, when the ability to earn income becomes fixed, understanding their budget will be imperative for their future financial success,” Mr. Ardrey says. “Without this in place, there is no way to accurately predict their future spending.”

Despite the budget shortcomings, he has used their retirement spending target of $80,000 per year for his projection. That is in addition to the cost of debt repayments.

Their investment portfolio is 97 per cent stocks and 3 per cent cash and bonds, for which the historic rate of return is 5.62 per cent, the planner says. Such a high proportion of stocks is too risky given how close they are to retiring. “They should already be reducing their risk to avoid a potential portfolio decline with a limited time horizon for recovery,” he says.

In retirement, Mr. Ardrey assumes they will move to a balanced portfolio of 60 per cent stocks and 40 per cent fixed income. This reduces the projected return to 4.55 per cent. As most of their portfolio is self-managed, no fees were assumed, the planner says.

“Under these circumstances, Ed and Patti are unable to meet their retirement goal, running out of [investment assets] at age 88,” Mr. Ardrey says. “When the Monte Carlo analysis was used, it showed only a 41 per cent probability of success.” A Monte Carlo simulation introduces randomness to a number of factors, including returns, to stress test the success of a retirement plan, he says.

“To increase the probability of success, they could work longer, spend less, save more or, the ever-unpopular die earlier,” the planner says. For example, Patti could work another three years, to age 63, retiring at the same time as Ed. In addition, they could review their budget and increase their savings by $1,000 per month each from now to the time they retire, he says. They would contribute the extra money to their tax-free savings accounts.

“These two changes have a significant impact on the Monte Carlo simulation, increasing their probability of success to 93 per cent,” Mr. Ardrey says.

“Patti and Ed need to make some tough choices to make their retirement dream a reality,” the planner says. “They first need to get a good hold of their budget and spending so they will have more to spend in retirement.” Second, they need to work longer to increase the time they have to save. “Over all, having defined-benefit, indexed pensions will give them a good base, but they need some extra savings to enjoy some of the sweet things in life.”

Client situation

The people: Ed and Patti, both 58, and their two children.

The problem: Can they afford to retire early and spend $80,000 a year?

The plan: Track their spending a little more closely to see where the money is going. Plan to increase their savings by $1,000 a month. Patti could consider working three more years so they both retire at the same time.

The payoff: The lifestyle to which they aspire.

Monthly net income: $12,373.

Assets: Cash $6,900; her TFSA $28,700; his TFSA $2,105; her RRSP $45,085; his RRSP $175,770; residence $775,000; estimated present value of her defined-benefit pension $684,865; estimated present value of his DB pension $402,865 (based on 3 per cent inflation and a 5-per-cent discount rate). Total: $2.1-million

Monthly outlays: Mortgages $2,095; property tax $455; water, sewer, garage $65; home insurance $75; electricity $110; heating $250; security $40; maintenance, garden $110; transportation $436; groceries $800; clothing $180; gifts, charity $475; vacation, travel $600; dining, drinks, entertainment $350; personal care $120; club memberships $40; sports, hobbies $50; miscellaneous personal $300; drugstore $10; life insurance $380; cellphones $275; TV $50; internet $130; RRSPs $800; TFSAs 0; pension plan contributions $1,545. Total: $9,745. Unallocated surplus $2,619.

Liabilities: $87,420 at 1.99 per cent due 2025 and $64,140 at 1.92 per cent due 2026.

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

Interest Rates – what is happening, why it is happening, and what we are doing about it

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March 13, 2023

In 2022 we saw a steep global rise in interest rates at a pace few could have ever expected. Even into 2023, many central banks are still indicating they are not finished and more needs to be done to bring stubbornly high inflation back to their 2% target.

Heading into the new year many expected interest rates to continue to climb for the first half of the year and then pause or even decline in the latter half. While the Bank of Canada recently made the decision to pause further interest rate increases, the US Federal Reserve has continued to push ahead, repeatedly noting there is more to do and the increases thus far have not had the needed impact.

Interest rates have continued to be a significant driver of uncertainty for investors so we wanted to provide an update on what we are doing to manage this volatility and address some of the important questions you may have had yourself.

It’s worth noting where interest rates and inflation stand today.

Inflation

  • Headline inflation in Canada cooled to 5.9% January, down from a peak of 8.1% in the Summer.
  • US headline inflation peaked at 9.1% in June, but presently stands at 6.4%.
  • Inflation remains elevated globally which has had significant impacts on our everyday spending and although it continues to cool, it will not be in a straight line.

Interest Rates

  • The Bank of Canada has paused interest rates at 4.50%, rising from 0.25% in 2021.
  • The US Fed interest rate stands at 4.75%, also up from 0.25% in 2021.

What caused inflation to get so high?

Too much money chasing too few goods and services is ultimately what drives inflation. Government stimulus during the pandemic was a life saver for many households and companies but the impact this stimulus had on the economy was not intended to be this long. Consumers still have excess savings and, although many of the pandemic driven supply chain issues have been resolved, consumers continue to spend. This accompanied by the strong job market and associated rise in wages has added fuel to an already hot economy.

What are central banks trying to accomplish with higher interest rates?

Higher interest rates are an attempt to slow consumer and business activity across the economy – and, by extension, inflation – by making debt-based spending more expensive. Big ticket items, like homes and cars, begin to cost more because buyers are paying higher interest rates for their mortgage and other loans.

It’s also worth noting that interest rate increases take time to work through the economy. While those with a variable rate mortgage may feel the impact immediately, other forms of spending like business expenses take longer to feel the impact.

Why is Canada pausing interest rate increases while the US continues to climb higher?

There is a variety of reasons why this may be happening, but a significant factor is how our two economies are structured and what household consumer debt looks like.

Canadians carry much more debt than the average US consumer. This is especially true as it relates to mortgage debt. Many Canadians carry variable rate mortgages that are subject to 5-year renewals. This differs from many US homeowners who, after the 2008-09 financial crisis, shifted away from variable rates and towards fixed rate options. Prior to 2008, 40% of US households had variable mortgages, while only 10% have variable mortgages today. Our neighbors to the south also benefit from 30-year terms, meaning they are less likely to be faced with a renewal in the near term at today’s higher rates.

These are notable differences and mean that Canadians have felt the brunt of increasing interest rates much more quickly than Americans. This also means that as interest rates have climbed in the US, the intended impact of driving down spending has not happened as quickly when compared to past periods of increasing interest rates.

Will higher interest rates drive us into a recession?

If we do enter a recession in the near term this will likely be the most foreseen recession in history. Every day we are inundated with news that a recession is coming but no one can agree when. Recently, the Wall Street Journal published an article titled “Why the Recession Is Always Six Months Away”. This is largely a play on many economists constantly having to revise their expectations as a recession fails to materialize.

Employment remains very strong in Canada and in the US and wages continue to grow. This, coupled with continued consumer spending, is not a characteristic you would expect heading into a recession.

  • Canada added 150,000 jobs in January compared to a Reuters survey estimating 15,000.
  • In the same period, the US added 517,000 jobs compared to an expected 185,000.

The below chart looks back at past recessions and how interest rates have developed over time.

Also of key concern is the inverted yield curve. While the details of this phenomenon are not important in this forum, what’s important is this signifies that investors expect interest rates to rise in the near term but that those hikes will ultimately damage the economy, forcing rates back down over time.

  • Investors have used this as an indicator for a pending recession. Typically, an inverted yield curve puts a recession 11 to 14 months away from that point on. This would have us see a recession in October at the earliest.

How severe of a recession will we see?

This is the million-dollar question driving fierce debate among economists, politicians, and investors.

Most are betting on a “soft-landing” characterized by a gradual reduction in inflation and a slowing but still strong economy. Despite this, the longer interest rates remain elevated and the higher they get, the greater risk of a policy error by central banks resulting in a more severe and prolonged recession.

What is TriDelta doing?

No one knows for sure what the next several months will bring and we continue to be active within our portfolios with a focus on ensuring we are able to preserve capital and look to be opportunistic when others let emotion drive decisions.

  • Both of our actively managed equity funds continue to have a higher allocation to cash than historic norms.
    • This tactical exposure to cash allows us to take advantage of opportunities in the market and benefit from a greater income yield with many money market funds yielding almost 5%.
  • We manage volatility using options contracts which help to limit near term downside in the funds. These contracts allow us to protect portfolios on the downside while still allowing for upside if markets swing to the positive.
  • Just as in 2022, our focus is on companies with strong and stable cash flows, tenured management teams, and those often paying a healthy dividend.
  • Bonds had their worst year on record in 2022 and have become much more attractive in recent months.

  • As the interest rate dynamic has changed so too have the expectations around the stock market. Rising income yields for bonds have added to the volatility seen in stocks as investors weigh the perceived safety in greater income yields from bonds relative to the riskier stocks.
  • Interest rates are likely to remain higher for longer and unlikely to get near 2021 levels anytime soon. This changing dynamic will play a significant role moving forward and we stress the need for actively managed portfolios to work through this.
  • In our year end commentary, we spoke to the disappointing returns investors in “balanced portfolios” saw in 2022. These largely passive stock/bond only portfolios experienced much more downside than investors anticipated and, today, are providing income yields often worse than holding money market funds.

  • Alternative investments were a top performing asset class in 2022 and helped to dampen volatility. Our clients benefited from this added diversification away from strictly stock and bond portfolios.

Investors are keenly aware of inflation and have looked for any signs of easing inflation as a likely positive for the market as a whole. On the other side, any sign of a strengthening economy has actually been a negative as investors see this as evidence inflation is not falling and will therefore lead to higher interest rates. We have looked closely at all our portfolios and continue to be confident in our ability to protect on the downside and take an unemotional view of the markets to see opportunity where others may see risk.

The uncertainty we saw in 2022 and continue to see moving forward will keep many investors fearful of the future. We remind ourselves regularly that, despite this uncertainty, risk is lowest when price is lowest and coming off a year where stocks had their worst year since 2008 and bonds had their worst year ever, there are decisions we can make today which will have positive long-term value for our clients.

 

4 steps to getting investment income without paying the CRA more taxes

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February 15, 2023

Most investors like a high-income yield, but are you one of them? Do you need monthly income to pay your bills? Is this income earned in a taxable account? If you don’t need the monthly income from investments and you have taxable investment accounts, there is likely a way to lower your taxes.

Let’s start with the basic tax payable on investment income in a taxable account. In Ontario, if you are in the top tax bracket (income of more than $235,675), your marginal tax rate will be the following depending on type of income: Interest income: 53.53 per cent; non-Canadian dividends: 53.53 per cent: ineligible Canadian dividends: 47.74 per cent; eligible Canadian dividends: 39.34 per cent; capital gains: 26.77 per cent; and return of capital: zero per cent.

For greater clarification on a few items, depending on the income of the corporation, many private-company dividends could fall into either eligible or ineligible. For return of capital, it is zero per cent today, but it essentially serves as a deferred capital gain.
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The order of the list stays largely the same regardless of your income, except at lower income levels when the eligible Canadian dividend comes in at a lower tax rate than capital gains.

In general, earning steady income from investments makes sense even if we’re talking about lowering investment income in taxable accounts. A study of the S&P 500 going back 80 years found dividends made up between 25 per cent and 75 per cent of total returns depending on the decade. As a result, I am a fan of dividends, but how do you balance this with a lower tax bill?

With this tax knowledge as background, here is a four-step process to balance a desire for income with a lower tax bill.

Allocate appropriately among accounts

Tax-sheltered accounts such as the registered retirement savings plan (RRSP), registered retirement income fund (RRIF), tax-free savings account (TFSA) and registered education savings plan (RESP) are all good places for income investments that may not be taxed. Interest income and United States dividend income (other than in the TFSA) are ideal for these accounts. Even high-dividend investments might be a better fit here.
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If you don’t have any taxable accounts (non-registered or corporate), then being strategic about where investments sit is generally not very relevant.

If you do have taxable accounts, it is important to try to allocate the most tax-efficient investments to the accounts that will owe tax. This might mean holding investments in a non-registered or corporate account that generate no income, return of capital or eligible Canadian dividends.

Do you really need monthly or quarterly income from investments?

Are you drawing funds to cover expenses? If so, having steady investment income is likely of value. If not, there isn’t any cash-flow need to earn more investment income. You might even prefer holding stocks with no dividend or zero-coupon bonds.
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Even if you require a monthly cash flow, keep in mind you can still sell an investment to raise this cash. From a tax perspective, if it is in a taxable account, this will generate capital gains (or losses), and each dollar will result in a lower tax rate than interest income.

Find more tax-efficient investments

Alphabet Inc., Constellation Software Inc. and many other stocks don’t pay any dividend at all. These types of stocks tend to be growth companies, and lean towards technology, so there are risks, but they will generate no income for tax purposes until you sell them.

Real estate investment trusts (REITS) with high return of capital can provide you with cash flow, but still no tax bill in a current year. Public REITs can have high income, but a sizable return-of-capital component. For example, Slate Grocery REIT has a current yield of 7.4 per cent. In 2021, 58 per cent of its income was return of capital and another 12 per cent was capital gains. There are also many private REIT investments where all income is return of capital.

Consider a home equity line of credit

This strategy is currently out of favour because interest rates are high, but it is often a lower-cost source of cash flow if you would otherwise need to draw funds out of your RRSP, RRIF or corporate account.

Given that it could create a tax bill in the 40-to-50-per-cent range, it might be more tax efficient to get cash with a borrowing cost in the single digits. Of course, low single digits would be better.

This strategy makes the most sense when your funds would otherwise not be taxed for many years. It can be less valuable if you are simply deferring the tax on the income for a year or two.

It can also make sense in some cases for retirees who would otherwise lose some or all their Old Age Security benefits because their taxable income is too high.

Like most things in life, balance and nuance can be important. They say you shouldn’t let the tax tail wag the investing dog. That said, paying meaningfully higher taxes than is necessary should at least get you to pay attention to that wagging tail.

Reproduced from the National Post newspaper article 14th February 2023.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP®, CIM®
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

TriDelta Insight Q4 Commentary – Putting 2022 In Its Place

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January 16, 2023

Market Overview

2022 was a rollercoaster year that saw war between Russia and Ukraine, fears of an energy crisis, surging inflation, and central banks raising interest rates at a pace not seen in decades.

While it’s impossible to summarize a year in just a few sentences there are several points from 2022 worthy of note:

  • Stocks had their worst year since 2008. Bonds had their worst year on record.
  • Market movements continued (and will continue) to be driven by the expectations versus realities of interest rate changes.
  • Inflation rates in Canada and U.S. appeared to have peaked and have continued, albeit slowly, to come down.
  • Recession concerns will continue to be top of mind as we wait on whether central banks can avoid inflicting additional hardship.
  • The conflict between Russia and Ukraine, while tragic, has become less of a concern for the market in the latter half of the year.
  • Economic activity has been slowing, and some countries are likely in a recession today, but others remain reasonably healthy.
  • Commodities remained one of the few bright spots for the year, helping the Canadian market outperform many peers.

While some of these worries will continue to drag markets, no one can know for sure how exactly 2023 will look when it’s all said and done. Our views continue to be cautious, but we are increasingly seeing long-term opportunities when looking at all the volatility being experienced globally.

Year to Date Returns

How did you do?

Do-it-yourself investing became a well talked about phenomenon during the early days of COVID lockdowns. Established financial news outlets found themselves reporting on the success of “meme stocks”, NFTs, cryptocurrency, and the larger than life individuals behind these risky endeavors.  Have you ever wondered how these same investors did in a year when not everything went up? We did, and fortunately, we were not alone.

According to data compiled by Vanda Research, the average active amateur investor suffered losses of approximately 30% in 2022. JPMorgan Chase & Co. was even more downbeat about these amateur traders, estimating they saw losses of 38%. (Retail Traders Lose $350 Billion in Brutal Year for Taking Risks – Bloomberg)

Even the traditional balanced portfolio of 60% stocks/40% bonds was down over 15% at its lowest in 2022 and finished the year down over 11%.

While no one likes to see the dollar value of their portfolio decline, we think these figures and the ones in the market returns chart seen above pose an important reminder of what value working with an experienced team can provide.

While each individual portfolio is unique and depends on many different factors, we have been very happy with how our clients have fared in 2022. Our outperformance relative to the broader markets can largely be attributed to:

  • Our continued focus on active risk management,
  • Taking emotion out of the decision-making process,
  • Exposure to energy markets in most portfolios,
  • Developing a well-diversified portfolio that can withstand the ups and downs of the market, and
  • Our inclusion of alternative investments with less correlation to public markets.

Why the next 10 years won’t look like the last 10

The last bull market was 13 years in the making and born out of the Great Financial Crisis of 2008/09. This recession was a difficult time for many reasons outside the scope of this commentary but what is important is what came afterwards:

  • Consumers significantly lowered their debt to disposable income (unless you were Canadian).
  • We saw persistently low inflation and slow economic growth. This allowed central banks more leeway to stimulate the economy and drive asset prices higher.
  • Markets enjoyed strong and steady gains. Companies were able to borrow at next to nothing and investors bet on companies they assumed could grow exponentially in this new normal.

For years investors, economists, and bankers speculated when this bull market would come to an end, but no one foresaw a global pandemic as the underlying reason. A pandemic that drove the excesses of the previous decade to new highs, buckled supply-chains, and finally showed that inflation would not be low forever. We have discussed several times this year that while we believe inflation has likely peaked and will continue to come down from its highs, it is likely to remain well above the central banks 2% target to which they have become accustomed.

What does this mean moving forward?

  • Central banks won’t be able to act as freely. Interest rates will rise and fall but are not likely to reach their previous lows any time soon.
  • Households and companies will need to rethink their spending.
  • The market should still trend higher over the long run, but the highs and lows will be more abrupt.
  • The “winners” of the last decade are not certain to be the winners of the next decade. You can’t drive a car looking in the rear-view mirror. Buying something simply because it is down 30+% does not mean it is a good investment.
    • Technology stocks provide some history. Prior to 2022, tech stocks grew to become 30% of the S&P 500 and every time an industry has been 30% of the S&P 500 it has then underperformed the next 10 years.
    • We analyzed a winner from the early 2000’s tech bubble earlier in the year: TriDelta Financial – Market Commentary for June 2022

Much of this probably seems ominous, but if anything, it has only made us more excited for what’s to come. Will there be difficult years like 2022? Yes. But with each period of volatility there is far more opportunity for the long-term investor than the short-minded trader. We think the value of working with an active manager will be increasingly important moving forward. We are not only investment managers, we help to manage emotions so the households we work with can keep their long-term goals in focus. The risk of a market correction in our mind is not that portfolios have declined but that a client sacrifice achieving their goals in favour of short-term comfort.

The value and importance of financial planning alongside investment management

These days, it can be downright depressing watching the news too closely.  Depending on which news source you watch, it is hard not to get despondent.  Often, the cure for this is to step far back and look at your personal situation, your immediate world, and not get so worried about the global issues that you can’t control.

We find that financial planning becomes even more important in times like today as it allows you to focus on your world much more than the big, bad world.  Just like stepping away from the online news, to focus on your smaller world, a financial plan review allows you to get a better handle on how you are doing, and any adjustments you can make in your world to better align with your goals.

By looking at your taxes, debt, income, estate planning and insurance, it allows us to put your investments in context with your overall picture, goals and plans.  This can help us to manage not just the ups and downs of the investment market, but the risk required to meet your overall goals.

What we are doing and why

A couple of weeks back, Ted Rechtshaffen, President & CEO of TriDelta Financial wrote a featured article in the Financial Post discussing his thoughts for what’s to come in 2023.  It provides an overview of the world as we currently see it, and we think may come about in the year ahead. In case you didn’t see it, we are providing a link here.

23 investing and personal finance thoughts for what’s to come in ’23 | Financial Post

Stocks/Equities

Worries remain that central banks will raise interest rates too high, and a severe recession will follow. On the other side, worries are central banks will not do enough or governments will introduce stimulus too soon which will prolong the issues and do little to bring down inflation. Both scenarios will have material impacts to investment portfolios but there’s a case to be made that a recession could be the optimal outcome in terms of facilitating a sustainable path towards long-term growth.

Historically speaking, a central bank induced recession is easier to rebound from than a structural failing like what we saw in 2008/09. If a short and mild recession gets the economy back on its low-inflation track, that could be preferable to a world in which high inflation persists for years.

We have mentioned all year that markets are not likely to sustain a prolonged uptrend until we have greater clarity around the path of interest rates. Heading into 2023, the path of markets hinges, as always, on economic growth, corporate profitability, and — most importantly — whether inflation abates, and we can stop raising interest rates.

As we have already written, the last 10 years are very unlikely to simply be repeated when markets finally recover.

  • The last cycle centered around growth-oriented stocks (i.e., tech) while the next cycle is likely to be focused on high-quality companies with stable and growing cash flows, often paying a dividend and trading at a much more reasonable level than some of their high-growth peers.
  • With inflation being more elevated, the winners and losers in this environment will depend on those that can better contain costs.
  • We continue to expect Canada to perform well in comparison to global peers. Canada was a relative stand out in 2022 with economic growth likely finishing in the 2.5%-3% range.
  • We are not simply looking for companies trading at discounts relative to their pre-2022 highs. Some companies are justifiably down. Companies with poor debt management, inexperienced management teams, and slim cash flows should likely be avoided.
  • Both TriDelta equity funds continue to use cash tactically to take advantage of significant price swings as we expect to remain cautious in the first months of 2023.
  • Areas we like moving forward include:
    • Healthcare – the population isn’t getting any younger. Healthcare is the third-best performing industry of all time, and it has just come off a three-year period of underperformance.
    • Energy – despite the recent volatility there remain a lot of strong fundamental reasons to be confident in energy. There are also a lot of uses of oil and gas for which there is no substitute such as plastics, vitamins, fertilizer, drug ingredients, flavors, and fragrances.
    • Globally (outside of North America), markets have seen meaningful selloffs and are often trading at much better valuations than their U.S. peers, creating an attractive entry.
    • Emerging markets pose an attractive entry point at current levels. A potentially weakening US dollar, new optimism around a Chinese reopening, and valuations at extreme lows all bode well for these companies in the near term.

The TriDelta Pension and Growth Funds performed exceptionally well in 2022. The Pension and Growth funds were -1.09% and -6.96%, respectively. Following a strong 2021 where the Pension and Growth funds returned +16.4% and +28.5%, 2022’s performance is evidence to the risk management strategies we employ within the funds and why capital preservation is always an important consideration.

Bonds

As mentioned earlier, bonds had their worst year on record and because of this decline have become a much more attractive space for both income and capital gains. That said, not all bonds are equal and active management will be key to ensuring we take advantage of this asset class in 2023.

Some important aspects to note include:

  • There is a broadening belief there will only be one or two more interest rate increases occurring in the first half of 2023 and then subsequent declines in rates as early as the latter half of the year.
  • Central banks have been adamant that they disagree with this assessment and do not forecast cutting rates in the second half of the year.
  • Key to the future of interest rates will include inflation continuing to fall and a weakening labour market in North America.
  • As we saw with the United Kingdom in 2022, government decisions to use fiscal spending to spur growth would likely force central banks to raise interest rates higher than expected.
  • Globally, we expect currency changes to be volatile. Much of this change will be influenced by government decisions in the face of declining economic growth. Fundamentally we see the Canadian dollar as lower than what it should be.
  • Limited Recourse Capital Notes (LRCNs) have been an important addition to our inclusion in bond portfolios. With yields currently averaging around 7.5% on new issuances, we foresee further issuance into 2023 at potentially even greater yields.

Preferred Shares

Preferred shares ended a difficult 2022 down 20% on the year. Pressure from Limited Recourse Capital Notes and tax loss selling into year-end were significant detractors to close the year. Preferred shares continue to be a space we monitor closely as income yields have continued to rise, yielding 6.3% on average, and investors have benefited owning preferred shares that have been redeemed in 2022 with 15% of the Canadian market being redeemed by issuers.

Alternatives

2022 was a year where alternatives demonstrated a lot of value in client portfolios. Private credit and real estate returns remained broadly strong and have been one of the lone positives in portfolios. We continue to have regular conversations with our managers and have continued to add new funds to our offering.

  • Private debt stands as a beneficiary of rising interest rates as they are able to pass along these rates to borrowers and expand their pool of opportunity as more companies are no longer able to seek traditional bank financing.
    • Rates on these loans are up 4% in most cases and referrals continue to come from the banks themselves.
  • Private real estate has performed much differently than their publicly traded peers. While the impact of rising interest rates is being felt across the space, not all types and geographies of real estate are the same.
    • Many of our managers operate in niche markets which has provided insulation from these changing rates while rent increases have continued to climb as the long-term case for rentals persists.

In Conclusion

In five years’ time we see it as a very real possibility we will look at 2022 as a year people look back on as having been a great opportunity for investors. Stocks in 2022 had their worst year since 2008 while bonds had their worst year ever recorded. We know first-hand that there is no one on our team who would say they wouldn’t go back in time and put everything they could in the market in late 2008 but we also know hindsight is 20/20. We still think there will be ups and downs in 2023 and beyond but having a long-term focus will be what ultimately protects your portfolio and helps you succeed.

If you would like to discuss your financial plan or investment portfolio, please give us a call or send a note.

 

FINANCIAL FACELIFT: Can Duncan and Lorna afford to retire early and leave their children a big nest egg?

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January 9, 2023 , , ,

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.

gam-masthead
Written by: Dianne Maley
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.

Client situation

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

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

23 investing and personal finance thoughts for what’s to come in ’23

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January 3, 2023


As we headed into 2022, I shared 22 financial thoughts for 2022. As it turned out, they were largely accurate, with one meaningful exception. I predicted an increase in interest rates and inflation, but, like many others, the hikes exceeded my more modest view. Looking towards 2023, interest rates and inflation will once again be key to our financial future, so let’s start there.

Inflation will slowly and fairly steadily decline in 2023: We will likely get back to the range of three to four per cent by the end of the year in Canada. The declines may not be as fast as we hope, but the reduction in inflation will be welcomed on many fronts and will certainly relieve some of the pressure on interest rates.

Expect to see the first interest rate declines late in 2023: Interest rates have almost peaked from a central bank perspective, and while they may not go down for a while, I expect to see the first declines late in 2023. This is a little earlier than the Bank of Canada is currently indicating. Unfortunately, it will not give any immediate relief to those with variable-rate mortgages.

Five-year fixed mortgage rates will not decline; they may even rise: From a bond-market perspective, the five-year rate is unreasonably low given the rest of the market. While my earlier thought relates to the Bank of Canada rate, we believe there needs to be an upward adjustment in five-year bond yields to normalize the yield curve from the inverse yield curve we have today. We expect this will happen in the first half of 2023.

Residential real estate will go down, then up: Economic fears do not make major financial decisions such as buying a house easy. Between higher mortgage rates than many have seen in their lifetimes, some fears around employment and those who might need to sell because of lost jobs, I see a weaker market in early 2023. That said, immigration targets of 465,000 people will be very supportive of the overall market, and I expect a small housing recovery later in the year.

Rents will go up, then maybe down: Greater demand from larger immigration combined with those who can’t afford to buy anything will continue to push rents higher in the early part of 2023. But we expect this to lose steam somewhat as the real estate market comes down and the overall economy is weaker. The practical implications are that some people will adapt to this, leading to more people per residence, either because children are living at home longer or people add roommates to be able to afford rent.

Recession? Yes, but manageable: It seems fairly clear that central bankers’ efforts to slow inflation down will slow growth down. The technical definition of a recession — two or more consecutive quarters of negative growth — will likely take place. Nevertheless, high immigration numbers and the potential support of lower interest rates should keep us out of a major recession.

Unemployment will rise: Recessions lead to lower earnings and higher unemployment. Along with a greater number of people looking for work due to immigration, we would expect to see unemployment rates rise to more than six per cent by year-end from 5.1 per cent currently.

Working from home will be reduced: The work-from-home trend isn’t going away, but there is nothing like a recession and higher unemployment to motivate employees to do what their companies ask. If cutbacks are looming and you are asked to work from the office four days a week, you don’t want to be the one that says no.

Retirements will be delayed: Many people approaching retirement age are looking to continue working, because rising inflation is creating some justified concerns. The greater ability to work from home has also made the decision to extend work a little easier for many. Considering some of the low employment rates we have seen, many employers are more than happy to accommodate extra years of work from older employees.

Government pension payouts will be meaningfully higher: This isn’t so much a prediction as a fact that hasn’t received a lot of attention. Inflation has some benefits for retirees as government pension payouts will grow 6.3 per cent in 2023. Canada Pension Plan (CPP) payments as well as Old Age Security (OAS) are tied to inflation, so if you can maximize those benefits, you could receive as much as $24,000 combined in 2023. And OAS benefits are a little higher still for those 75 and older.

Inflation means higher tax thresholds and OAS clawback limits: The OAS clawback will kick in once personal income is $86,912 in 2023 as opposed to $81,761 in 2022. This may allow increased planning opportunities to capture more OAS. In addition, the top federal tax bracket will move up to $235,676 from $221,709, along with smaller increases at all tax bracket levels. There may be some additional planning in 2023 to help take advantage of these changes.

Energy costs will be increasingly dependent on China: I believe that the prices of oil and natural gas will not meaningfully decline in 2023, but the emergence of China from COVID-19 restrictions could support strong energy demand. China is always difficult to predict, but it seems likely that China will follow the rest of the world in meaningfully easing COVID-19 restrictions over time. This will be the biggest driver of prices in 2023. Of course, an ongoing conflict in Ukraine and Russia could also provide some price support.

Metals and materials will recover in 2023: After a big drop off in the last eight months of 2022, China will be supportive of growth in metals and materials prices. This will be key as a global economic slowdown will move prices the other way. Overall, we think the recovery of China demand will carry the day.

The loonie will stay in the low end of its seven-year range: The Canadian dollar has since 2015 spent most of its time trading within a few cents of 76 cents U.S. Today it is around 74, and we expect it to mostly be in the 72-to-74 range. One of the big reasons will be the United States ending up with a higher interest rate than Canada.

Ukraine and Russia will continue to raise risks: We would obviously like to see a resolution of the conflict, but there doesn’t seem to be a clear route at this point. This leaves challenges for many markets such as energy, wheat and uranium. Unfortunately, the ongoing conflict will likely lead to continued supply challenges in these markets and result in higher-than-normal prices.

Bitcoin will survive but likely won’t see a meaningful recovery: Last year, I didn’t even want to comment on bitcoin. With the current FTX debacle, government regulation will become much tighter. Smaller cryptocurrencies may not survive, and the largest names will have to survive under much tighter scrutiny, which goes against the prevailing culture of independence. I think that is called growing up.

Cannabis stocks need U.S. legalization and that isn’t likely to happen: The window might have been open for the legalization of cannabis in the U.S. for the past couple of years, but it clearly wasn’t one of President Joe Biden’s priorities. That doesn’t seem to have changed. As a result, it will be tough to see real gains in this space.

There will be an increased demand for financial and estate planning: As uncertainty grows about the economy and inflation, there is more concern about our own financial futures as well as those of our children and grandchildren. We saw this in 2009, and many Canadians in 2023 will be searching for those who can provide greater guidance, financial peace of mind and tax-minimization strategies.

Canada will outperform U.S. markets again: U.S. markets had until 2022 largely outperformed Canada for a decade. From 1999 to 2010, though, Canada had largely outperformed the U.S., which suggests there are longer-term trends at play here. With the bloom off the rose of high-growth tech stocks, a return to better value and a resource recovery, the advantage for Canada looks to continue. We also expect Europe to do better because the current overall view is too negative today.

Larger-cap, profitable and good-cash-flow stocks will be the place to invest: They will benefit from a desire for stability from investors as well as the ability to use their capital to target those that need to raise money (see Royal Bank of Canada’s purchase of HSBC Holdings PLC’s Canadian business.)

Bonds will perform much better: Bonds had a historically bad year in 2022. But the fundamentals are different today. It is possible to find yields to maturity of five to seven per cent. We don’t expect much help for bonds in 2023 from rate declines (probably more help in 2024), but the much higher starting yields will help overall returns.

The health-care crisis will lead to greater spending on the sector: I don’t pretend to know the correct medicine for a Canadian health-care sector that seems to be breaking at the seams. But I believe governments will face great political pressure to invest more in a variety of resources to support the industry. Also, expect Canada to keep things relatively easy to get approved for medical assistance in dying (MAID).

2023 will see better overall returns: It may be a bumpy ride and a low hurdle, but higher income yields will be supportive of balanced portfolios in a way that we didn’t see in 2022. In addition, the flattening interest rate environment will help. A recession will hurt earnings, but we expect meaningful return improvements overall.

Reproduced from the National Post newspaper article 29th December 2022.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP®, CIM®
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221
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