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FINANCIAL FACELIFT: Have Margaret and Simon saved enough to meet their retirement spending goal?

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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:
Special to The Globe and Mail
Published January 7, 2022

Margaret is age 61 and recently retired. Her husband Simon, who is 70, retired from work five years ago. Although neither has a pension, they have a home in the Greater Toronto Area, a cottage, and substantial savings.

“We are looking for advice on how to draw down our assets for the best tax advantage and longevity of our funds,” Margaret writes in an e-mail. Over the past year or so, they withdrew $100,000 from their savings to lend to their daughter to help with a down payment. As well, they bought a new truck.

Short term, they have some foundation work to do on their cottage and they’re planning a trip to Europe.

Simon is drawing $16,800 a year from his registered retirement income fund. He’s getting $12,170 in Canada Pension Plan benefits and $8,255 in Old Age Security. Margaret recently converted her registered retirement savings plan to a RRIF as well and is wondering how much she should draw. She also wonders when to begin collecting CPP and OAS benefits.

Their retirement spending goal is $8,000 a month, or $96,000 a year, after tax. Have they saved enough?

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Simon and Margaret’s situation.

What the expert says

Margaret and Simon want to take stock of their situation and ensure they will have enough to enjoy their retirement, Mr. Ardrey says. They have investment assets of $800,000 ($76,000 in their tax-free savings accounts and the remainder in RRIFs) plus real estate assets of $2.1-million, which include their home and cottage. The cottage has about $400,000 in imbedded capital gains.

“They are willing to sell the cottage to make their retirement work, “but they want to keep their house. “I would agree with their thinking,” the planner says. “With rising costs of long-term care, I believe in keeping the house aside as insurance against these costs and as a financial buffer in a retirement plan.”

Aside from these assets, they have lent their daughter $100,000 toward a home down payment that she is repaying at 1-per-cent interest over 10 years. As well, they recently bought a truck using funds from their TFSAs. While there are no tax implications from this withdrawal, they might have been better off borrowing the funds, he says. “If they could have financed at a low rate, then they would have been better off doing that than using portfolio assets.”

Simon’s income consists of withdrawals from his RRIF and government benefits, for a total of $37,225 a year. The forecast assumes Margaret begins taking CPP and OAS at the age of 65 because the penalties for taking the benefits earlier are “very punitive and are generally not recommended,” Mr. Ardrey says. “We assume 75 per cent of the maximum CPP and full OAS for Margaret,” which will add another $24,865 a year in future dollars.

They want to spend $8,000 a month starting this year. “Based on the above assumptions, they are not able to meet their objectives,” the planner says.

“The goal of the projection is to have enough to cover their spending until Margaret’s age 90, leaving the principal residence intact to cover off any future health care costs,” he says. To avoid the punitive losses of taking CPP early, they must make additional withdrawals from their RRIFs, which are all taxable.

“They run out of investment assets in 2034, when Simon is 83 and Margaret is 74, where we assume they sell the cottage,” Mr. Ardrey says. Even then, they run out of investment assets a second time in 2047. Margaret, who would be 87, would be forced to sell the house at this time to fund her expenses for the remainder of her life.

“This adds the risk of failure to this projection because she would no longer have the financial cushion,” he says. “Although it could work under ideal conditions, life is not always ideal.”

Although the projection works if she sells the house, “things look worse if the projection is stress-tested using a Monte Carlo simulation,” Mr. Ardrey says.

A Monte Carlo simulation introduces randomness to a number of factors, including returns, to stress-test the success of a retirement plan. “In this plan, we have run 500 iterations with the financial planning software to get the results,” he says. For a plan to be considered “likely to succeed” by the program, it must have at least a 90-per-cent success rate, meaning at least 450 trials out of 500 succeed. If it is below 70 per cent, then it is considered unlikely.

“Even if Margaret sells the house in 2047, the probability of success in this plan is only 51 per cent,” Mr. Ardrey says. “To achieve 100 per cent success with their current portfolio construction, they would need to reduce their spending by almost 20 per cent to $6,500 per month.”

Their current portfolio has an expected future return of 2.82 per cent a year on average, the planner says. This is owing to the 60 per cent weight in fixed income. “By changing their portfolio mix to achieve a 5 per cent return (a 3 per cent real rate of return above 2 per cent inflation), the probability of success jumps to 92 per cent,” he says. In his forecast, Mr. Ardrey uses an asset mix of 60 per cent stocks, 20 per cent non-traditional investments and 20 per cent fixed income. “If in addition they lower their expenses by $500 a month to $7,500, the likelihood of success increases to 100 per cent and removes the need to sell their home.”

For the past 40 years or so, fixed income has been a safe haven for investing, the planner says. “This is less so today.” Fixed income faces risks of rising interest rates. An increase in interest rates leads to a decline in the price of existing bonds. Additionally, it has inflation risk. “If the current rate of inflation is stickier than predicted, the real rate of return on bonds will be negative.” In short, Simon and Margaret need to consider taking on more stock market risk and less interest rate and inflation risk, the planner says.

Client situation

The people: Simon, 70, and Margaret, 61.

The problem: How should they draw on their assets to meet their retirement spending goal? Have they saved enough?

The plan: Strive to cut spending. Plan on selling the cottage and investing the proceeds. Consider professional money management to boost investment returns. Margaret may have to sell the family home at some point.

The payoff: The realization they will have to temper their aspirations.

Monthly net income: $8,070

Assets: Cash in bank $50,000; combined TFSAs $76,000; combined RRIFs $724,000; mortgage to daughter $100,000; grandchild’s education savings plan $23,370; cottage $900,000; residence $1.2-million. Total: $3.07-million.

Monthly outlays: Property taxes $1,000; water, sewer, garbage $80; property insurance $290; electricity, heating $390; maintenance, garden $585; transportation $880; grocery store $895; clothing $40; gifts, charity $525; vacation, travel $350; other discretionary $200; dining, drinks, entertainment $865; personal care $25; club membership $20; pets $600; sports, hobbies $175; subscriptions $140; other personal $25; health care $350; communications $475; grandchild’s registered education savings plan $165. Total: $8,075.

Liabilities: None.

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

22 financial thoughts on what’s to come in ’22

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Predicting the future has always been a challenge, and it has become almost impossible with Omicron. That said, I’m optimistic things will considerably improve on the COVID-19 front in 2022, at least from the second quarter onward.

This belief is based on a mix of hope and science that there will be a high enough percentage of people who are fully vaccinated and/or been infected with the Omicron variant so that the tide will turn on this pandemic.

My belief certainly colours my 22 thoughts for 2022 below.

1) Interest rates will stay low. Yes, interest rates will likely rise from extremely low to very low in 2022, but don’t confuse rising rates with high rates. Act as though we are in a very low interest rate world.

2) Energy and metals likely have more room to run. Oil has been so unloved that the valuations on some big 2021 gainers remain super low. Many in the sector have forward price/earnings ratios in the seven range, which is much lower than their historical average and much lower than the overall market.

3) Canada should outperform global markets. This is based in part on having a very small percentage of high-growth/no-profit tech stocks, as well as an overweight to commodities.

4) Increased immigration should help lower wage inflation. This assumes COVID-19 doesn’t hold up this process for too long. More workers at all levels will reduce some of the wage inflation we are currently seeing.

5) Increased immigration should keep residential real estate prices up. Low interest rates, a steady economy and high immigration rates are the three-legged stool for increasing residential real estate prices. Prices went up even without the sizeable net immigration piece during the past two years. The immigration numbers should compensate for the slightly higher rates.

6) Cottage country real estate prices may slow down a little. I say may since it is very much COVID-19 related. As more people work from the office and more people are comfortable travelling internationally, I truly believe there will be a real slowdown on vacation property real estate in Canada. How long it will take to see those drops is the question.

7) Spending will grow. Many people have considerably dropped their spending levels in the past two years. If you kind of feel like you have lost two years of your life, you will try to make up for it — COVID-19 willing.

8) Your car will be more important. There will likely be a significant lag in the comfort level of going back to public transit as more people head back to the office. This will lead to more money being spent on cars, and likely more traffic jams.

9) Your house will be less important. Of course, this is all relative, but we will likely be spending less time in our homes (although it doesn’t feel like it right now). This means more money for concerts, restaurants, travel and experiences, and less for home gyms, swimming pools and gazebos.

10) Living life can mean indulging in things that aren’t so good for you : alcohol, drugs, tobacco, sex, gambling, etc. Sin stocks may do well as the return to living (and spending) has to go somewhere.

11) Fitness and wellness may slip in importance. This isn’t to suggest there are any major negatives in these areas, which have experienced sizable growth over the past few years, but it is somewhat the corollary of thought No. 10.

12) Online shopping and food delivery are here for good, but not with the same buzz. The stock market is forward looking and is always looking at momentum. I believe some of the momentum in this area will decline.

13) Build back better … sort of. There remain some aggressive infrastructure projects and spending that will happen, but it will likely end up being Build Back Better Junior Edition if the United States is any example.

14) Taxes may not be headed higher . There is a clear rationale to raise taxes to help get us out of the huge debt situation, but there are two things in the way. The first is the belief we can grow ourselves out of debt, which may be partially true. The second is the current government is much more comfortable giving money away than asking for more.

15) Demand for mortgages and home equity lines of credit will continue to grow . Even with some increase in rates, the only thing that will stop this area of growth is a flattening or decline in real estate values. This can certainly happen, but it likely won’t be this year.

16) Rent costs will rise . As residential real estate values rise and interest costs rise, the desire among landlords to boost rental rates will be very high. Lack of overall supply will simply make this worse.

17) Retirement residences will still manage to grow. There is no question the pandemic has increased the desire for many seniors to stay at home. Yet with older baby boomers now clearly in this market, the costs of staying home increasing, and the lottery ticket of housing values waiting to be cashed in for many, don’t be surprised if this market continues to grow — in some cases with the ability to buy as opposed to rent.

18) Cryptocurrencies will exist. I know this is a cop-out thought, but the only thing I know for certain is that governments are going to significantly increase the regulation and taxation of this space. Beyond that, I won’t predict anything.

19) Investment fundamentals will return. Something is broken when the IPO of Rivian Automotive Inc., an electric car company with no sales, values it at more than three times that of Honda Motor Co. Ltd. In a world of uncertainty, there will be greater value placed on actual profits and dividends, and less on the companies priced for perfection five years out.

20) Bonds will still struggle. This asset class is broad enough to find some winners, but the core vanilla bond space will find it hard to deliver returns with a combination of low yields and rising interest rates.

21) Inflation is here to stay … for now. I don’t want to use the word “transient” here, but at some point later in the year, inflation will pull back to the range of two to three per cent. This is largely because inflation is measured year over year, and it will be much harder to see five-per-cent inflation rates when compared to the fourth quarter of 2021.

22) The search for investment yield will grow. Many investors like the steady income from an investment portfolio, but there will be an increasing focus on staying ahead of inflation and taxes. This will likely put even more of a premium on investments that can deliver this type of yield.

Reproduced from the National Post newspaper article 31st December 2021.

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

What is our Investment Thinking Today?

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Are Stocks Expensive?

If you are talking the Nasdaq U.S. market, the answer is yes.  If you are talking the S&P500 U.S. market, the answer is probably yes.  If you are talking other markets, then the answer may be no.

One measure of valuation is the Forward Price/Earnings multiple, or P/E multiple.  The higher the number, the more expensive the market.

The S&P500 is at 21.3.

The Nasdaq is at 24.6.

In comparison, the Canadian TSX Composite is only at 14.9.

The British FTSE100 index is at 12.4.

The broader Euro Stoxx index is at 15.5.

The Emerging Market index is at 12.5.

Of interest, the TSX has a lower Forward P/E at the moment than it has had for most of the past 3 years.

Another view of the U.S. large cap S&P500 is what is known as the Shiller PE ratio.  This is a different way of measuring valuation.  The Shiller PE is currently at 38.6, which is considered 49% higher than the 20 year average, and very close to the 20 year high.

What Sectors are Less Expensive that we like?

While the process is definitely not as simple as more expensive and less expensive, it should be noted that the five least expensive sectors are Financial Services, Energy, Consumer Defensive, Utilities and Industrials.  The most expensive are Consumer Cyclicals, Real Estate and Technology.

In an environment of rising interest rates and inflation, we continue to like Financial Services, Energy, and Industrials.  These are sectors that should also see some benefits from increased infrastructure spending.

While we are not making significant Geographic shifts, we are very focused on avoiding too much exposure to sectors that we deem expensive and more heavily impacted by interest rate hikes.

Where do dividends fit in?

According to the Hartford Funds, dividend income’s contribution to the total return of the S&P 500 Index averaged 41% from 1930–2020.  Clearly dividends matter.

At a time when bond yields are lower than inflation, there is a greater demand for stocks that can pay a higher dividend.  Of course, that doesn’t even include the benefit of owning Canadian Dividends in a taxable account – which has a much lower tax rate than interest income.

In summary, we like dividend growers with good balanced sheets, we will lean a little more heavily here in 2022.

TriDelta Equity Funds

In 2021, our TriDelta Growth Fund had a return of 28.5%.  This outperformed our equity benchmark of 23.2%.

The Growth Fund is an active fund that looks to adjust its approach throughout the year to be properly positioned for where we see the market today.  We use quantitative analysis as the foundation along with a historical review of how market sectors reacted previously to similar market environments.

Our TriDelta Pension Fund had a return of 16.4%.  While not as strong as the Growth Fund, this fund has a different mandate.  Also using quantitative analysis as a foundation, we focus very much on balance sheet strength, and on long term dividend growers.  This approach aims at less variability, downside risk and higher dividend yields.

The Bond Market is difficult in this environment

Financial heavyweight Citi says that bonds Globally will return negative 1% to 0% in 2022.  This asset class is broad enough to find some winners, but the core vanilla bond space will find it hard to deliver returns with a combination of low yields and rising interest rates.

Where we own bonds, we are leaning shorter term, as they will provide some protection as the market is pricing in too many rate hikes.  What we mean by this is that the market is now pricing in nearly 6 hikes over the next year. We do not see anything near that happening.  It still means rates are going up, but not nearly as much as some think it might.

We do believe that there will be some tactical opportunities here in “next-best” companies like the Rogers/Shaw deal.  Sometimes M&A activity can lead to opportunities.  We would expect more leverage as companies try to borrow as much cheap money as they can, while they can.

Bonds are not cheap but most things are not either, so selective and tactical is our approach.

The Preferred Share Market has fewer opportunities than 2021

Fixed Rate or straight preferred shares are bumping up against a ceiling for enhanced returns.  Many are yielding decent dividends in the 4.5% to 5.25% range today, but have prices at or above $25, with the risk of being called at $25.  This doesn’t mean it is a bad place to invest, but the very strong returns from 2021 be very unlikely to be repeated in 2022.  In 2021, Rate Reset preferred shares saw returns of 29.5%, while straight preferreds had a 9.2% return.  While the 9.2% number pales in comparison, it was still a very solid return for this asset class.  We still see some good opportunities in rate resets but expect both of those return numbers to be meaningfully lower.

One of the challenges in the preferred share market is that the market is shrinking as banks and some oil and gas names redeem issues in favour of cheaper financing via  specialized bonds.  What this means is that investors have to put a premium on the surviving issues, pushing their valuations into and often above their redemption prices.  This is a sector of the market where understanding the details of the company, their capital requirements and the specific terms of a preferred share is extremely important.  It can add meaningful value to buy specific securities vs. the index and some ETFs (although ETFs can be of value for smaller transactions).

Relatively speaking, resets and floaters (this is a pretty small market in Canada) enter the year as a better value than straights due to the rising rate outlook.  We would be looking to avoid reset and floater issues with large reset spreads and approaching reset dates. They are likely to be called and are probably trading at a premium to redemption price. For now, non-bank and non-oil and gas prefs are less likely to be redeemed as issuers have fewer refinancing options and should be safer places to invest.

We will continue to buy straights on dips, especially when rates are moving in a volatile fashion to the upside.  Barring an inflationary mistake, the rate hiking cycle will be a short and small one.

Inflation will be high for the short term, but should come down later in the year and early 2023

Inflation will remain in the mid single digits for much of the year, 4-5%, give or take, but may weaken late in the year.  Whether it is COVID restrictions, sustainability compliance efforts, speculation in commodities, low unemployment or consolidation-induced pricing power, there will be pricing pressures through 2022, but below peak levels seen in 2021.

Alternative Income Strategies – Most are performing well

While Bridging Finance was the big story in this space in 2021, the rest of the industry continued to deliver solid gains.

Alternative Real Estate funds had a good year, with our top fund returning over 26%.

Mortgage funds continued to perform, with returns in the 6% to 9% range.

Our top Private Debt funds should end the full year in the 11% range, with others solidly in the 7% to 8.5% range.

As greater transparency and valuation standards are in place, we continue to see this sector of investing as a key part of most investors portfolios.

 

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

FINANCIAL FACELIFT: Can Owen and Emily afford to retire next year and spend winters overseas?

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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:
Special to The Globe and Mail
Published November 5, 2021

Owen and Emily – freelancers in their early 60s – amassed $1.7-million in financial assets the old-fashioned way. No inheritance or real estate windfall helped them. They raised two children, now 22 and 29, and their house in small-town Ontario is fully paid for.

They each draw a salary of $36,000 a year from their corporation, which bills about $130,000 a year.

“The lower cost of living here might have played a small role, but we always spent less than we earned,” Owen writes in an e-mail. “We paid for our house after eight years and we have invested our savings in passive investments, mostly exchange-traded funds, on a buy and hold basis,” he writes.

Emily and Owen are hoping to hang up their hats next year and travel, spending Canadian winters overseas. They wonder whether they can contribute $25,000 a year for a few years for their younger child’s overseas studies. Their retirement spending goal is $70,000 a year, much more than they are spending now.

“What is our best strategy to withdraw our investment money to support our lifestyle?” Owen asks.

We asked Matthew Ardrey, a vice-president, portfolio manager and financial planner at TriDelta Financial in Toronto, to look at Owen and Emily’s situation.

What the expert says

Owen and Emily are looking to retire next summer after years working at a successful business, Mr. Ardrey says. “Before they do, they want to ensure that they have accumulated enough assets to make the switch from earning a living to enjoying retirement.”

They are saving the maximum to their tax-free savings accounts. Any other surpluses are being held in their personal and corporate bank accounts, the planner says. The higher spending they anticipate will be for travelling and “focusing more on enjoying life,” the planner says. Their current spending has likely been constrained by the COVID pandemic, he adds.

Emily and Owen would like to support their son for the next five years while he is overseas by giving him $25,000 a year, Mr. Ardrey says. “If this is not feasible, it’s not necessary, but it’s certainly something they would do if they could.”

Part of what they would like to understand is how to draw down or “decumulate” the assets they hold in their corporation, their registered retirement savings plans and their TFSAs, “not to mention a sizable balance in their cash accounts,” the planner says.

He suggests a fixed draw on the corporate assets to create a steady income stream much like a pension. Spreading out the income they receive also will help keep their tax bill down, he says. “This would provide them with $2,000 per month (total) starting in retirement, indexed to inflation.”

Mr. Ardrey recommends they “melt down” their RRSP assets before they take Canada Pension Plan and Old Age Security benefits. They could take withdrawals of $20,000 each a year, which would create a level income stream until they start collecting government benefits at age 65. The forecast assumes they will get 70 per cent of the maximum CPP benefit.

Before analyzing their retirement cash flow, the planner says he must first analyze their portfolio construction. “If we ignore the large cash balances, which will likely be used to pay for their son’s living costs overseas, they have a portfolio that is about 87-per-cent stocks and 13-per-cent fixed income,” Mr. Ardrey says. “Though that mix is great for accumulation, it has considerable volatility risk inherent in it, which is not appropriate for decumulation,” the planner says.

“On top of the volatility risk, there is significant company-specific risk, with one stock making up 32 per cent of the entire portfolio.” This stock has a huge imbedded capital gain, he notes. “The only saving grace is it is in the corporation, so selling the stock will increase the capital dividend account, allowing for tax-free withdrawal of part of the gain.”

The capital dividend account is funded by the non-taxable portion of a capital gain in a corporation, currently 50 per cent. This account permits tax-free withdrawals from the corporation by the shareholders.

In preparing his forecast, the planner assumes Emily and Owen reduce their stock exposure to 60 per cent in retirement and allocate the remainder to bonds. He assumes a rate of return on investments of 3.84 per cent (historical) and an inflation rate of 2 per cent. “Though adding bonds limits the volatility risk, it lowers the return they can earn, and also adds risks from inflation and interest rate increases,” he says. Even so, running the projection under these conditions allows them to meet their retirement spending goal and help their son with his expenses, Mr. Ardrey says.

“Things change if we stress-test the projection using a Monte Carlo simulation.”

A Monte Carlo simulation is a computer program that introduces randomness to a number of factors, including returns. “In this plan, we have run 500 iterations with the financial planning software,” the planner says. For a plan to be considered likely to succeed, it must have at least a 90-per-cent success rate. If it is below 70 per cent, then it is considered unlikely.

“In the case of Owen and Emily, they achieved a success rate of 89 per cent, so they are just under the likely marker,” he says.

“Owen and Emily’s diligent saving has made it possible for their retirement dream to be realized,” Mr. Ardrey says, “although with their portfolio in its current form, there are certainly some risks they need to address.” By addressing these concerns, he says, “they can improve the likelihood they will achieve all of their financial goals.”

Client situation

The people: Owen, 61, Emily, 62, and their two children, 22 and 29.

The problem: Can they afford to retire next year with a budget of $70,000 a year after tax while still helping their younger child with overseas living expenses? What is the best way to draw down their savings?

The plan: Treat the corporate savings like a pension, making regular monthly withdrawals that rise with inflation. Melt down their RRSPs as much as possible before taking government benefits.

The payoff: A secure retirement with enough money to travel and winter overseas.

Monthly net income: $5,655

Assets: Cash in bank $135,000; cash in corporate account $89,000; stocks in corporate account $766,000; his TFSA $77,800; her TFSA $77,500; his RRSP $280,500; her RRSP $310,450; remainder of registered education savings plan $12,600; residence $700,000. Total: $2.4-million

Monthly outlays: Property tax $380; water, sewer, garbage $115; home insurance $50; electricity, heat $165; maintenance, garden $190; transportation $350; groceries $550; clothing $30; gifts, charity $35; vacation, travel $600; other discretionary $200; dining, drinks, entertainment $215; personal care $10; pets $20; club membership $15; health care $140; communications $95; TFSAs $1,000. Total: $4,160. Surplus of $1,495 goes to unallocated spending and saving.

Liabilities: None.

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

FINANCIAL FACELIFT: Can Sébastien and Sofia afford a new cottage on top of their other financial goals?

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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:
Special to The Globe and Mail
Published September 24, 2021

Sébastien and Sofia are in their late 30s with three children, ages 10, 7 and 5. Sébastien works in education, Sofia has gone back to university to get an advanced degree. Their family income is about $200,000 a year. It will rise once Sofia begins full-time work.

“Thus far, Sofia and I have been very careful with our money,” Sébastien writes in an e-mail. “We have avoided debt and we have done well with our investments,” he says. “Our decisions are rarely based on money and almost always on our values, life goals, and what kind of education we want to offer our kids.” The Montreal couple are planning to move to a larger apartment in the next few years to make more room for their family. They want to give their children the option of attending a private high school if they choose. Private schools in Quebec cost about $7,000 a year. They also want to help with their higher education.

An unexpected opportunity has landed amid these well-ordered plans: Sébastien and his brother have been asked whether they’d like to buy the family cottage, a small, three-season place that requires extensive rebuilding. “It’s been in the family for three generations,” Sébastien writes. After the renovation, each family would spend some time at the cottage, and rent it out when they’re not there to help cover expenses.

Can they do it without jeopardizing their other goals? Sébastien asks. If so, how should they finance the purchase and renovation?

“We are not too worried about retirement, but we are more concerned about the period when the kids will go to high school,” he writes.

We asked Matthew Ardrey, a vice-president, portfolio manager and financial planner at TriDelta Financial in Toronto, to look at Sébastien and Sofia’s situation.

What the expert says

If they decide to buy and renovate the family cottage, Sébastien and Sofia will be sharing the cost with Sébastien’s brother 50/50 and expect the total amount to be $550,000, of which Sébastien and Sofia would pay $275,000, Mr. Ardrey says. To pay for the purchase and rebuilding, they have three options: Sébastien and Sofia could sell some securities and pay cash for their portion; together the partners could get a mortgage on the cottage at 2.39 per cent; or Sébastien’s brother could borrow against his condo at 1.05 per cent, with both partners being responsible for the loan.

“Selling securities will result in capital gains and a loss of investment income,” Mr. Ardrey says. “This would only make sense if they could set it up as a Smith Manoeuvre, making the loan interest tax-deductible,” he says. (If they sell some securities to pay for the cottage and then reborrow to reinstate the investments, the interest on the debt would then be tax-deductible.) They would need to compare the cost of taxes on capital gains against tax savings from deductible interest payments.

Financing with a mortgage is most likely the best option, the planner says. “The cost of debt today is very low, and as long as they can exceed the cost of debt with their investment returns, it is the preferable choice.” Their mortgage payments would be about $11,680 a year.

Though the rate of interest would be lower borrowing against the brother’s condo, they should try to avoid mixing business with family, Mr. Ardrey says. “If for any reason their financial circumstances change for the worse, their brother should not pay the consequences.”

In his forecast, Mr. Ardrey assumes they can get a mortgage for 80 per cent of the value. The remaining capital will come from Sofia’s portfolio because her income is lower and the tax consequences from the capital gains will be less.

Aside from the cost of the mortgage, Sébastien and Sofia expect the net effect on their budget will be an increase in spending of about $1,200 a year because they plan to rent the cottage out part-time to cover some of the costs. As well, having it will lower other vacation costs.

The forecast assumes Sébastien and Sofia move to a larger apartment in 2023, increasing their rent from about $1,500 to $3,000 a month.

Their single largest spending year shows an increase of $26,500 with higher rent, private high school and cottage mortgage payments, Mr. Ardrey says. “That being said, with Sofia’s increased income, their annual surplus savings remain in the $25,000 to $30,000 range,” the planner says. “So there is a significant amount of cushion to deal with these added expenses.”

Sébastien and Sofia save $625 a month in a registered education savings plan toward their children’s higher education. Assuming a cost of $15,000 a year, including living expenses, for postsecondary education (lower due to Quebec’s lower tuition fees), they would be able to cover undergraduate degrees in full for their first two children and two-thirds of the cost for their third child. He assumes any shortfall is covered by Sébastien and Sofia from their personal investments.

Sofia and Sébastien make their annual maximum contributions to their tax-free savings accounts and save another $6,000 a year to Sofia’s registered retirement savings plan. Sébastien also contributes $920 a month to his defined benefit pension plan at work. “They note a surplus of around $49,500 a year in their questionnaire,” Mr. Ardrey says. They have already saved $27,000 as of the end of August. Thus any surplus is assumed to be saved.

“As their income increases and expenses like private school end, their surplus grows substantially and so we assume their annual savings do as well,” the planner says.

Sébastien and Sofia plan to retire at age 65, when they will get full Canada Pension Plan and Old Age Security benefits. Sébastien’s pension will pay him $60,280 a year, indexed to inflation. Their retirement spending goal is $80,000 a year after tax.

Their current asset mix is 4 per cent cash, 4 per cent fixed income, 11 per cent preferred shares and 81 per cent equities, which in turn are divided 47 per cent Canada, 41 per cent U.S. and 12 per cent international and emerging markets. This portfolio has had a historical return of 5.03 per cent. They are investing using stocks and exchange-traded funds, which keep costs down, so the planner assumes an average investing cost of 0.25 per cent.

“In retirement we assume that they need to make their portfolio more conservative to avoid the inherent volatility in their current mix,” Mr. Ardrey says. “We assume they move to a 60/40 equity/fixed income portfolio, which lowers their returns to a historical 3.84 per cent.”

Sébastien and Sofia can make their retirement goal with ease, the planner says. “In fact they could more than double their spending and still have funds left over.”

Client situation

The people: Sébastien, 38; Sofia, 39; and their three children.

The problem: Can they afford to buy and renovate the family cottage in partnership with Sébastien’s brother without jeopardizing their other goals? How should they finance it?

The plan: Take out a mortgage to finance 80 per cent of their share of the cottage, selling securities from Sofia’s portfolio to pay for the rest. Continue saving their substantial surplus.

The payoff: All goals achieved.

Monthly net income: $12,600

Assets: Cash $14,500; his stocks $401,455; her stocks $146,000; his TFSA $130,765; her TFSA $135,670; his RRSP $120,345; her RRSP $96,990; estimated present value of his DB pension $157,500; RESP $85,000. Total: $1.29-million

Monthly outlays: Rent $1,540; home insurance $40; electricity $30; car rental $200; other transportation $140; groceries $900; child care $420; clothing $200; gifts, charity $200; vacation, travel $500; dining, drinks, entertainment $380; personal care $20; sports, hobbies $500; subscriptions $20; dentists, drugstore $20; health, dental insurance $70; life, disability $90; communications $145; RRSPs $500; RESP $625; TFSAs $1,000; his pension plan $920. Total: $8,460. Surplus of $4,140 goes to non-registered savings account.

Liabilities: None.

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

FINANCIAL FACELIFT: Can Ben and Lucy retire in their 40s on just one income?

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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:
Special to The Globe and Mail
Published July 9, 2021

Ben and Lucy are in their early 40s with two children, no company pensions and a burning desire to retire very early. Lucy earns $59,000 a year, Ben $79,000 a year. Both have mid-level management jobs.

They own a $1.4-million house in Toronto – their former home – that they rent out for $3,600 a month. Last fall, they moved to a smaller community not far from the city, where they bought a house valued at $850,000. They have about $1.2-million of debt.

“What we would like to know is the best path to achieve a retirement with $55,000 a year income after tax,” Ben writes in an e-mail. “My wife is planning to quit her job soon.” Once Lucy stops working, Ben wonders how much longer he will have to work to achieve their spending target. “Should we sell the house in Toronto as soon as possible and pay off the mortgages and the home equity line of credit?” Ben asks. They would invest the net proceeds. Ben is anticipating a $400,000 inheritance in about 10 years.

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Ben and Lucy’s situation.

What the expert says

Lucy plans to stop working by month end, just before she turns 45, Mr. Ardrey says. Working from home during the pandemic led her to conclude she needed to spend more time with the children. Ben plans to retire in about 10 years, if possible, when he is 51.

They have an investment portfolio of about $770,000 in various accounts, invested in geographically diversified equities. The one exception is the leveraged investment account worth $447,000, which is all invested in the iShares S&P/TSX Composite High Dividend Index ETF. In addition to their investment portfolio, they own their home worth $850,000 and a rental property valued at $1.4-million.

Against these investments, they have a $473,000 mortgage on their principal residence, a mortgage and line of credit totalling $371,000 against their rental property and a loan of $385,000 against their investment portfolio, the planner says. These loans, other than the line of credit, come up for renewal in the next three or four years.

“With $1.23-million of debt, the risks associated with rising interest rates are considerable, especially when mixed with a reduction in family income,” Mr. Ardrey says.

Ben and Lucy are not setting aside money for retirement at the moment, but Ben is expecting a large inheritance. “Typically, I would exclude an inheritance from any financial projection unless it is quite certain, which in this case Ben feels it is.”

One of the main questions Lucy and Ben ask is whether they should sell their rental property or keep it. Mr. Ardrey prepared two scenarios. In the first, they keep the rental property. It earns them $3,600 a month gross, less expenses of $1,195 and debt repayment costs of about $1,330.

Ben and Lucy have been living frugally, spending about $43,000 a year excluding debt repayment, rental costs and savings. They want to loosen the purse strings a bit in a few years, increasing their spending to $55,000 a year to cover home repairs, a new car, children’s activities and more travel. Without Lucy’s income, they will need to draw about $3,000 a year from their investments, increasing to about $15,000 a year once they hike their spending.

Their current rate of return on their portfolio is 6.14 per cent, less an average management expense ratio of 0.29 per cent, for a net return of 5.85 per cent. “To maintain their asset mix at 100 per cent equities once Ben stops working would be very risky,” Mr. Ardrey says. So in preparing his forecast, he assumes they move to a balanced asset mix of 60 per cent stocks and 40 per cent bonds at Ben’s retirement. This lowers the rate of return to 4.1 per cent gross and 3.81 per cent net of MERs. When Ben receives the inheritance, the planner assumes they catch up with their contributions to their tax-free savings accounts and make their annual maximum contribution thereafter.

“In the first scenario, they can achieve their retirement goal, though with very little financial cushion if the rental property is never sold,” Mr. Ardrey says. Though there is a net worth of $7.7-million at Ben’s age 90, it is almost entirely real estate.

In the second scenario, they sell the rental property in 2022 and retire all of the associated debts. Based on a cost base of $790,000 there is a capital gain of $660,000. This capital gain is reduced by estimated selling costs of 5 per cent, or $72,500, making the net gain $587,500. The same investment drawdown and rate of return figures apply in this scenario. The one change is they fund their TFSAs earlier using the proceeds of the rental sale.

“In the second scenario, they can also achieve their retirement goal and have more financial cushion when doing so,” Mr. Ardrey says. Their net worth is $6.8-million at Ben’s age 90, but they are able to spend $24,000 more than their target each year – or $79,000 – from Ben’s retirement to his age 90, adding much more financial flexibility.

“Looking at these scenarios, it is apparent that there are some major risks to their retirement success,” the planner says. The first is future interest rates. “With so much debt, a rise in interest rates could have a significant impact on their monthly costs,” the planner says. The second risk is rates of return. Given the more than 50-year time horizon, Mr. Ardrey used what is called a Monte Carlo simulation – a software program – to stress-test the success of the couple’s retirement plan. For a plan to be considered “likely” to succeed, it must have at least a 90-per-cent success rate. Less than 70 per cent is considered “unlikely.”

Both the first and second scenarios fall into the “somewhat likely” category, with success rates of 75 per cent and 86 per cent, respectively. Because this is below the 90 per cent threshold, Mr. Ardrey suggests some changes to their portfolio allocation, replacing a portion with private investments such as real estate investment trusts or mortgage investment corporations.

To invest in these asset types, they will need to access them through an investment counsellor who could charge 1.5 per cent a year, tax deductible on non-registered accounts, he says. Such investments carry risks, but may lessen the reliance on traditional fixed-income securities on which yields are historically low.

Client situation

The people: Ben, 41, Lucy, 44, and their children, 7 and 9.

The problem: After Lucy quits this month, how much longer will Ben have to work to achieve a retirement spending target of $55,000 a year? Should they sell their rental property to pay off debt?

The plan: The scenario in which they sell the rental and pay off their debts offers a greater degree of security and allows them to spend even more if they choose to. Consider diversifying the investment portfolio into private, income-producing assets such as REITs.

The payoff: The path forward they are asking for.

Monthly net income: $14,030

Assets: Cash $19,000; ETFs $447,470; his TFSA $170; his RRSP $132,490; her RRSP $127,365; RESP $62,190; residence $850,000; rental property $1.45-million. Total: $3.09-million

Monthly outlays: Home mortgage $1,725; property tax $370; home insurance $100; utilities $385; transportation $180; groceries $950; clothing $50; line of credit $400; other loans $2,570; gifts, charity $120; rental property fees, tax, maintenance $1,195; dining, drinks, entertainment $250; pets $40; sports, hobbies $600; subscriptions $20; children’s activities $240; life, disability insurance $80; phones, TV, internet $190; RESP $165. Total: $9,630

Liabilities: Residence mortgage $472,915; rental mortgage $182,475; HELOC $188,430; investment loan $385,155. Total: $1.23-million

 

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
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