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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

FINANCIAL FACELIFT: Can Richard and Jane afford an expensive renovation without infringing on Jane’s retirement plans?

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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 May 28, 2021

Richard is 59, retired and collecting a defined benefit pension, not indexed, of $39,660 a year. He also has substantial savings and investments. Jane is 53 and works in health care, earning about $80,000 a year. She has recently joined her pension plan at work and has the option of buying back some years of service. She wonders if it makes sense financially to do so. She hopes to retire from work at age 60.

They also wonder whether they can afford a major renovation to their small-town Ontario house without infringing on Jane’s retirement plans.

“Can we afford to indulge our interest in architecture with a major modern home renovation valued at $300,000 and still have Jane retire when she turns 60 years of age?” Richard asks in an e-mail. Their house is valued at $700,000 with a $215,000 mortgage that they took out some time ago to invest. As a result, the mortgage interest is tax-deductible. They have cash and short-term investments of about $139,000.

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

What the expert says

Jane is earning $73,320 a year, plus $6,800, which her employer contributes to her registered retirement savings plan, Mr. Ardrey says. Jane and Richard maximize their tax-free savings account contributions annually. Any surplus they earn is being saved for their renovation, planned for 2022.

With no buyback, Jane’s pension will be $9,360 a year at age 60 indexed to inflation plus a bridge benefit of $2,280 until age 65. If she purchases the buyback for $168,000, the pension increases to $18,840 at age 60 plus a bridge of $4,560.

To fund the buyback, Mr. Ardrey assumes Jane transfers her existing RRSP and locked-in retirement account, which together amount to $114,000, to her pension plan. The remainder would come from their $50,000 guaranteed investment certificate and $4,000 from the joint bank account. “Whether or not she chooses the buyback will impact the funding for the renovation, so we will look at each scenario independently,” Mr. Ardrey says.

The average rate of return for their investment portfolio is 5.16 per cent, with an average management expense ratio of 0.29 per cent – resulting in a net return of 4.87 per cent. The assumed rate of inflation is 2 per cent.

They estimate their Canada Pension Plan benefit will be $1,100 a month for Richard and $1,000 a month for Jane at age 65. The forecast assumes they take Old Age Security benefits at age 65 as well.

In the first scenario, Jane does not take the pension buyback. They take all of their cash savings, which amount to $150,000 by mid-2022, for the renovation, financing the rest of the work on their line of credit at a rate of prime plus 0.5 percentage points, or 2.95 per cent. The forecast assumes they pay this off over 10 years.

“Using the cash, which has a negative real rate of return after inflation and taxes, is a good place to start,” the planner says. For the remainder, using debt over cashing in investments is preferred. With a rate of interest of only 2.95 per cent, the “hurdle rate” to earn more than that on their investments is low.

“That being said, they certainly have the assets to pay off the entire renovation,” Mr. Ardrey says. If they were to pay for it all with investment proceeds and then borrow against the line of credit to re-establish those investments, the interest would be tax-deductible.

“They should watch interest rates,” the planner says. “If rates rise, the hurdle rate would become higher and it may be more beneficial to pay off the debt rather than reinvest it.”

In retirement, they plan to spend $65,000 a year after tax and adjusted for inflation. At Jane’s age 90, there will be an estate of $8.4-million (with inflation), including investments and real estate. “If instead of leaving a large estate, if they exhaust all of their investment assets, leaving only real estate, they can increase their spending in retirement by $48,000 per year,” Mr. Ardrey says.

In the second scenario, he looks at what happens if Jane takes the pension buyback. “As this impacts their cash savings for the renovation, they will need to borrow $210,000 from the line of credit,” he says. The result is surprisingly similar. “With the increased pension and larger loan, we would expect to see a difference, but in fact the two scenarios play out almost identically,” the planner says.

“The most likely reason is the rate of return used in the forecast and the discount rate for the pension plan are virtually the same,” Mr. Ardrey says. (The discount rate is the rate of return assumed by the actuaries when calculating the current value needed to fund a future pension.)

Since the quantitative factors are identical, Jane and Richard need to look at other factors when making the pension buyback decision. These would include Jane’s life expectancy, the expected rate of return on the portfolio, their willingness to assume the investment risk versus the certainty of receiving pension income, the need for financial flexibility and how much interest rates are expected to rise over time.

“The main risk in each analysis is the asset mix of their investments,” Mr. Ardrey says. Their asset mix is 10 per cent cash, 3 per cent fixed income, 35 per cent preferred shares, 4 per cent in alternative investments and 48 per cent equities, of which about 80 per cent is in Canadian stocks or stock funds. “With about 75 per cent of their portfolio invested in Canadian stocks and preferred shares, some additional geographic diversification would be beneficial,” he says.

With preferred shares, an increase in interest rates can lead to a decline in value. As well, preferred shares can be more volatile than their traditional fixed-income counterparts such as corporate bonds, he adds.

Dividend income could also affect Old Age Security benefits. “Dividends are grossed up and an offsetting dividend tax credit is given to reduce the overall tax payable. The problem with this is that the grossed-up dividend is used in the OAS calculation, increasing the chances for the OAS clawback.”

To increase their diversification, Richard and Jane might consider adding some real estate investment trusts, private or publicly traded, to their investment mix, the planner says. “REITs that invest in a large, diversified residential portfolio or perhaps specific areas like wireless network infrastructure are preferable to one that has a large exposure to retail,” Mr. Ardrey says.

Client situation

The people: Richard, 59, and Jane, 53.

The problem: Can they afford an expensive renovation? Should Jane buy back some pension benefits?

The plan: The pension decision depends on considerations such as investment expectations, risk tolerance and their outlook for interest rates. Diversify their portfolio geographically.

The payoff: A clear view of their options.

Monthly net income: $8,820

Assets: Cash $89,000; GIC $50,000; his non-registered stocks $360,000; his private investment $60,000; his TFSA $100,000; her TFSA $88,000; his RRSP $510,000; her RRSP and locked-in retirement account $114,000; his defined contribution pension plan $100,000; estimated present value of his pension $700,000; his locked-in retirement account $52,000; residence $700,000. Total: $2.9-million

Monthly outlays: Mortgage $905; property tax $380; home insurance $50; utilities $180; maintenance, garden $320; transportation $755; groceries $670; clothing $135; gifts, charity $305; vacation, travel $670; dining, drinks, entertainment $630; personal care, club membership $55; pets $150; sports, hobbies, subscriptions $170; health care $115; disability insurance $70; communications $275; RRSP $565; TFSAs $1,000. Total: $7,400

Liabilities: Mortgage $215,000

 

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: Couple whose income has taken a big hit want to sell home and retire early by ‘leaning hard into dividends’

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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 March 12, 2021

A year ago, Frannie and Frank were earning a combined $100,000 a year after tax, Frannie in a restaurant, Frank in a bar. The value of their two-bedroom condo townhouse in Toronto was rising by the month.

Then the COVID-19 pandemic hit and they were out of work. Frannie is 37, Frank 31. They’ve managed to earn some money since then but they’re a long way from making ends meet.

“We are needing to make some huge and life-altering decisions,” Frannie writes in e-mail. Since they can’t foresee their income rebounding any time soon, they have decided to sell their townhouse. They plan to rent and invest the profit.

“Our thoughts are to lean hard into dividends,” Frannie adds. They’ve set their sights on one Canadian closed-end dividend income fund, attracted by its double-digit distribution. “How do we invest the dividends? Is this plan too high-risk? When can we retire? Can we retire?!?” Ideally, they’d like to hang up their hats at age 55 with $62,000 a year after tax to spend.

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Frannie and Frank’s situation. Mr. Ardrey also holds the certified financial planner and advanced registered financial planner designations.

What the expert says

“With the ultra-hot real estate market in the city, Frannie and Frank should have no problem selling their home and getting the price they want,” Mr. Ardrey says. They expect to get $950,000. They will pay off their mortgage of $377,500 and cover selling costs, estimated to be $66,500.

They plan to look for a smaller apartment for $2,000 plus $200 for utilities and parking. “This move will save them $650 per month in expenses.”

When the house closes, they plan to spend $7,000 on a vacation, leaving them with $499,000. They will both top up their tax-free savings accounts for a total of $120,000. “They may want to consider placing some funds aside for an emergency fund.”

Frank and Frannie plan to use the income from their investments to supplement their living expenses. They wonder whether their fund of choice is too risky.

“Aside from the risk of putting all their eggs in one basket, a deeper review of this fund has revealed a number of concerns,” Mr. Ardrey says. It boasts a yield of 10.97 per cent. “With a yield that high, how the distributions are generated is of utmost importance,” he says. “The fund does not hold anything that would generate that high a yield.” Instead, it generates its returns mainly through capital gains and return of capital; that is, giving investors some of their own money back.

When return of capital to unitholders becomes substantial, it can depress the value of the fund, Mr. Ardrey says. The fund’s return on capital has been around 47 per cent a year for the past four years – with the exception of 2019, when it was 88 per cent. Typically, fund distributions come from dividends and capital gains. In 2019, those accounted for only 12 per cent of the distribution. “For the rest, they had to encroach on capital.” The balance of the distribution for the past four years came mainly from capital gains – “not very typical of an income fund.”

The question is how long the fund company can sustain such high distributions, he adds. “What would happen if markets went through a prolonged downturn? It would likely be an unsustainable distribution.”

Finally, this fund locks in their investments, Mr. Ardrey says. Frank and Frannie would be able to redeem only once a year and when they do, they will get only 95 per cent of the value. “This is not an investment I would recommend they undertake.”

Instead, Mr. Ardrey looks at how the couple would fare with a diversified portfolio of 75 per cent equities and 25 per cent fixed income, and a historical rate of return of 4.78 per cent. If they invest with an online portfolio manager, they would pay 0.65 per cent in fees, leaving them with 4.13 per cent.

Frannie’s income is $19,000 a year, which she expects to remain static post-COVID, the planner says. Frank expects his income to rise from $44,000 back to its historical average of $56,000. The investment income alone will not be sufficient to meet the couple’s ongoing needs. They would need to start drawing down $4,000 a year of capital in 2022, increasing by $2,000 every few years, he says. “As time goes on, the frequency of these increases will rise as the capital pool diminishes.” By the time Frannie reaches age 55, the annual capital withdrawal would be $12,000 a year.

If they retire that early, Frannie will be entitled to 30 per cent of the maximum Canada Pension Plan benefit at age 65 and Frank 60 per cent, he estimates. The inflation rate is forecast at 2 per cent a year. “Based on these assumptions, they will run out of capital by 2051, when Frannie is 68 and Frank is 61.”

What if they worked another decade to age 65 and invested in the same portfolio? Working longer would have the effect of increasing their CPP benefits to 40 per cent of the maximum for Frannie and 75 per cent for Frank. “However, it would also add to the length of time they would need to be making pre-retirement withdrawals.” By the time Frannie retired at age 65, they would be withdrawing $22,000 a year.

“Leaving all other assumptions the same, they would still not be able to achieve their retirement spending goal,” Mr. Ardrey says. They would run out of capital by 2072, when Frank is 82 and Frannie is 89.

To improve their return, he recommends they hire an investment counselling firm and invest in a diversified portfolio of stocks, bonds and alternative income funds. Good-quality private income funds have returned 7 per cent to 9 per cent over the past few years with virtually no correlation to stock markets, he says. Private funds do have liquidity risk because they are subject to redemption periods.

“A portfolio like the one described above should be able to earn them 5 per cent net of investment costs or 6.5 per cent before,” the planner says. “With this change, they will reduce the amount needed from the portfolio pre-retirement,” he adds. They would start with $1,000 in 2026 and end with withdrawals of $14,000 when they retire. “So the improved returns delay the withdrawals by four years and reduce the amount needed at retirement by 36 per cent.”

These changes would be enough to put Frank and Frannie on the positive side of the ledger, but “the margin for error is very small.” They would be left with $575,000 at Frank’s age 90.

“So in addition to delaying retirement and improving their investment return, they must find a way to earn more income or reduce their expenses further,” the planner says. Because Frannie is in a lower tax bracket, the ideal would be for her to earn at least another $10,000 gross a year, he says.

Client situation

The people: Frank, 31, and Frannie, 37.

The problem: How should they invest the proceeds of their house sale? When can they afford to retire?

The plan: Invest in a diversified and balanced portfolio. Plan on working to age 65. Strive to make at least another $10,000 a year.

The payoff: A realistic assessment of what they need to do to achieve their goals.

Monthly net income (budgeted): $4,360

Assets: Bank $13,710; non-registered $17,020; her TFSA $10,105; his TFSA $1,520; residence $950,000. Total: $992,355

Monthly outlays: Mortgage $1,775; condo fee $475; property tax $250; utilities $240; home insurance $90; maintenance $25; transportation $600; groceries $720; clothing $100; gifts, charity $35; vacation, travel $0; dining, drinks, entertainment $0; personal care $50; sports, hobbies $65; pets $205; subscriptions $30; other personal $100; health care $30; phones, TV, internet $225. Total $5,015. Shortfall comes from savings. (Discretionary spending on travel, dining out, entertainment has been suspended.)

Liabilities: Home mortgage $377,500

 

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: Lucinda wonders how to organize investments after the coronavirus accelerated her decision to sell her house

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Below you will find a real life case study of an individual 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, 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 August 7, 2020

At the age of 60, Lucinda is going from being without contract work and collecting the Canada Emergency Response Benefit to wondering how to invest and manage about $1.5-million – the net proceeds from her house sale in downtown Toronto. The deal, for a total of $1.7-million, is set to close in September.

“The [COVID-19] pandemic accelerated my decision to sell my house in case of a significant drop in housing prices,” Lucinda writes in an e-mail, and because contract work in communications is now hard to come by.

“I fear I won’t be able to find work anymore, meaning I might need to cut into my savings, which I wanted to avoid. So now I need guidance on how to map out my retirement savings strategically,” she adds.

“My plan had been to take a few months off to attend to house repairs and then look for another contract in the spring,” Lucinda writes. “Then the pandemic hit and the contracting job market – combined with my experience level – led me to conclude it may take a very long time, if ever, for me to be employed again.”

She has no plans to buy another place and has rented an apartment for September. A key goal is to help her daughter, her only child, who has just graduated from university, to get established.

A self-directed investor who uses a mixture of mutual funds and exchange-traded funds, Lucinda wonders how best to structure her investments to last a lifetime. She also wants to leave as much as possible to her daughter. She wonders, too, when to begin collecting Canada Pension Plan benefits. Her target retirement spending goal is $45,000 a year after tax.

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

What the expert says

“Like many Canadians these days, Lucinda’s working life has been cut short by COVID-19,” Mr. Ardrey says. “So taking stock of her financial picture today and where it is going in the future is a prudent exercise.”

Lucinda estimates she will net $1,474,000 from her house sale after she pays off her mortgage and covers closing costs, the planner says. Her existing portfolio is a mixture of ETFs and mutual funds with an asset mix of 48-per-cent stocks and 52-per-cent cash and fixed income. The stocks are slightly overweight to Canada, but are otherwise well diversified geographically, he says.

“The historical returns on her portfolio asset mix are 4.39 per cent, with investment costs of 0.79 per cent, leaving her with a net return of 3.6 per cent,” Mr. Ardrey says. If inflation is assumed to be 2 per cent, this leaves her with 1.6 per cent above inflation, he adds.

If Lucinda sticks to her modest spending target of $45,000 a year to the age of 90, she would leave an estate of about $2.4-million in 2050, the planner says. She could spend another $42,000 every year before exhausting her capital. “That being said, I would not recommend this level of spending unless it is nearer to the end of her life, because there is no real estate to fall back on as a cushion.”

Lucinda has expressed concern about the direction of the stock market and low returns on fixed-income securities, the planner says. “She certainly has justification for her concerns.” The five-year Canadian government bond yield is a scant 0.31 per cent. “Though bond [prices] have had a great 2020 so far, in part due to interest-rate cuts, the long-term future of this asset class is definitely in question,” Mr. Ardrey says.

First off, Lucinda may want to look to an actively managed bond fund portfolio with solid yields that she can continue to hold for the coupons (interest payments), Mr. Ardrey says. Actively managed funds tend to do better in difficult markets. She is holding bond ETFs, most of which passively track market indexes.

With her increased wealth, Lucinda should consider hiring an investment counselling firm, which is required by law to act in the best interests of its clients, he says. (For a list of such firms, see the Portfolio Management Association of Canada website at https://pmac.org/.)

These firms can “create a strategy for her that will provide solid, ongoing income from both traditional and alternative asset classes,” the planner says. He recommends an asset mix of 50-per-cent equities, 20-per-cent fixed income and 30-per-cent alternative income – a class that includes funds that invest in private debt and income-producing real estate. The addition of alternative income investments, which do not trade on public markets, has the potential to boost fixed-income returns while offsetting the volatility of stock markets.

“The next couple of years will continue to be volatile in stocks,” he says. “But if she can ignore the volatility and focus on the dividend payments, she can use that income to pay for her lifestyle (with government benefits) without drawing on her capital.”

Lucinda should invest her new capital gradually, especially when it comes to buying stocks, Mr. Ardrey says. “I would not want to see Lucinda invest a substantial amount of capital, only to have the markets fall 20 per cent the following month.”

As for when to start taking Canada Pension Plan benefits, the planner suggests Lucinda wait until she is 65. “If Lucinda took her CPP at age 60, she would get $7,848 a year. So by the time she turned 74, she would have collected a cumulative total of $109,872 ($7,848 multiplied by 14 years).”

If she waited until age 65, Her CPP would be $12,144 a year. In 9 years, she would have collected $109,296.

“So, if Lucinda lives beyond age 74 and a few months, she would be better off taking CPP at age 65 than 60,” the planner says. Getting the larger amount starting at 65 would overtake the advantage of getting the smaller amount earlier starting in her 74th year, he adds.

Client situation

The people: Lucinda, 60, and her daughter, 26.

The problem: How to invest the proceeds of her house sale to last a lifetime and leave an inheritance for her daughter. When to take CPP.

The plan: Start CPP at 65. Consider hiring a professional investment counselling firm. Enter the stock market gradually. Consider actively managed bond funds and alternative fixed-income investments to potentially boost returns and lower volatility.

The payoff: The comfort of knowing she may be able to spend a little more than she plans and still leave a substantial estate.

Monthly net income (budgeted): $3,750.

Assets: Bank accounts $52,000; mutual funds $48,400; TFSA $61,500; RRSP $374,600; net proceeds of house sale $1.5-million. Total: $2-million.

Monthly outlays (forecast): Rent $1,650; home insurance $15; electricity $50; transportation $150; groceries $400; clothing $50; vacation, travel $300; personal discretionary (dining, entertainment, clubs, personal care) $500; health care $230; phone, TV, internet $90; miscellaneous future discretionary spending $315. Total: $3,750.

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
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Should Wilfred and Wendy diversify their Canada-heavy stock portfolio as they inch closer to retirement?

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Below you will find a real life case study of a couple who are 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, 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 3, 2020

Now in their 50s, Wilfred and Wendy plan to hang up their hats soon, sell their Manitoba house and move to a warmer clime. Wilfred is 58, Wendy, 53. Wilfred retired from his government job a few years ago and is now collecting a pension and working part time. He plans to continue working until shortly before Wendy is 55, when she will be entitled to a full pension. Both have defined benefit pensions indexed 80 per cent to inflation for life that will pay a combined $82,956 a year.

“We want to travel more in our younger years, so we would likely need more income in the first few years of retirement,” Wilfred writes in an e-mail. Their retirement spending goal is $75,000 a year after tax plus $25,000 a year for travel. With no children to leave an inheritance to, “we want to use up all our invested funds,” he adds. “We are extremely active, healthy people who have good chances of living a long life.”

They’re considering moving to British Columbia for the “milder winter weather and greater recreational opportunities,” Wilfred writes, but would only do so if they could buy for about the same price as their existing house fetches.

The stock market drop this spring left them feeling their investments are not sufficiently diversified, Wilfred adds. “I would like to diversify our stock holdings away from Canada only.”

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

What the expert says

Wilfred is planning to retire fully in the spring of 2021 and Wendy in January, 2022, Mr. Ardrey says. “With the goal in site, they would like to ensure that they are financially ready for the next stage in their life,” the planner says.

First off, the pair do not keep an accurate budget, Mr. Ardrey says. “As we went through this exercise, they revised their monthly spending upwards by $1,200.” The updated numbers are shown in the sidebar. “Before they retire, I would strongly recommend that they do a full and accurate budget, he adds, because a large discrepancy in their spending “could have a dramatic effect on their financial projections and their ability to meet their obligations in retirement.”

Wendy has three options for her pension, the planner says. She can take $3,874 a month with no integration of Canada Pension Plan and Old Age Security benefits. Or she can take $4,320 a month to the age of 60 and $3,688 a month thereafter with CPP integration. The third choice is $4,621 a month to the age of 60, $3,989 a month to 65 and $3,375 a month thereafter with integration of both CPP and OAS.

According to the pension administrator’s website, the purpose of integration is to provide a more uniform amount of income throughout retirement, rather than having less income initially (prior to CPP and/or OAS eligibility) and more income in the later years (when CPP and OAS commence). Integration provides an opportunity to increase the cash flow early in retirement which, for some, is preferred.

“I thought it would be interesting to compare her three options to find which would be the most lucrative over her lifetime,” Mr. Ardrey says. Option No. 1 is the clear winner, he says, giving the largest cumulative value of payments to the age of 90.

To illustrate, by 72 Wendy will accumulate $961,000 of pension with no integration, compared with $956,000 with integration of CPP and OAS.

In drawing up his plan, Mr. Ardrey assumes Wendy chooses the first option and that they both begin collecting government benefits at 65. He also assumes they buy a condo in B.C. in 2023 for about the same price as they get selling their current home. Because it is a long-distance move, he assumes transaction and moving costs total $100,000.

“Before we can discuss their retirement projection, I need to address their investment portfolio,” Mr. Ardrey says. Wilfred is right to think they need to diversify, the planner adds. They have a portfolio of nearly $800,000 invested almost all (97 per cent) in Canadian large-cap stocks. “Further concentrating their position, they have that 97 per cent spread over only 13 stocks, and of that, 62 per cent is in only five stocks,” Mr. Ardrey says. This exposes them to “significant company-specific risk,” he says.

As well, the Canadian stock market is not as diversified by industry as U.S. and international markets, so it can lag at times. “For example, in the recent market recovery, financials and energy have been lagging, which are two of the three major sectors on the TSX,” he says.

To illustrate, the planner compares the performance of the TSX and the S&P 500 indexes from Dec. 31 and from their February highs to the market close on June 24. The TSX is down 10.4 per cent from Dec. 31 and down 14.8 per cent from February. The S&P, in contrast, is down 5.6 per cent from year-end and down 9.9 per cent from February.

“Having a portfolio almost entirely allocated to stocks in retirement is a risk that Wilfred and Wendy cannot afford,” Mr. Ardrey says. He offers two alternatives. The first is a geographically diversified portfolio with 60-per-cent stocks or stock funds and 40-per-cent fixed income using low-cost exchange-traded funds. Such a portfolio has a historical rate of return of 4.4-per-cent net of investment costs.

Or they could hire an investment counsellor that offers carefully selected alternative income investments with a solid track record, Mr. Ardrey says. Adding these securities to their portfolio ideally would lower volatility and provide a higher return than might be available in traditional fixed-income securities such as bonds, the planner says.

Either way, they meet their retirement spending goal of $75,000 a year after tax, plus $25,000 a year for travel until Wilfred is 80.

Client situation

The people: Wilfred, 58, and Wendy, 53

The problem: How to ready themselves financially to retire in a couple of years.

The plan: Draw up an accurate budget, continue saving and take steps to diversify their investment portfolio to lower volatility and improve returns.

The payoff: Financial security with a comfortable cushion.

Monthly net income: $11,230

Assets: Bank accounts $51,000; his stocks $78,000; her stocks $135,800; his TFSA $86,500; her TFSA $78,000; his RRSP $232,217; her RRSP $186,767; estimated present value of his pension plan $464,000; estimated present value of her pension plan $677,417; residence $425,000. Total: $2.4-million

Monthly outlays: Property tax $270; home insurance $75; utilities $185; maintenance $200; garden $50; transportation $580; groceries $600; clothing $200; gifts, charity $200; travel $2,000; dining, drinks, entertainment $350; personal care $150; subscriptions $50; dentists $30; health and dental insurance $100; cellphones $130; cable $200; internet $130; RRSPs $1,025; TFSAs $1,000. Total: $7,525

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
matt@tridelta.ca
(416) 733-3292 x230
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