Articles

FINANCIAL FACELIFT: Should millennial savers Sid and Kamala hit pause on their plans to buy a house?

0 Comments

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 May 22, 2020

Fear of missing out has inspired millennials Sid and Kamala to save diligently in hopes of buying a house in the Greater Toronto Area. They also think they’re “bleeding money” by paying rent, Sid writes in an e-mail.

Sid is 34 and earns $55,000 a year in the hospitality industry. Kamala, who is 29, earns $35,000 a year in health services. The house they are eyeing is $880,000. For now, though, the house-hunting is on hold because Kamala and their toddler are stuck overseas, where they were visiting family.

“My question is whether to stay put in the rental market and focus on investing, or get into the housing market by depleting my savings,” Sid writes. “If we buy a house valued at $880,000, will we have any savings left for retirement?” They hope to retire from work when Sid is 60 with $48,000 a year after tax in spending.

In the meantime, they are planning a big trip. “Our dream is to go to Serengeti [National Park] in Africa to see the wildlife migrations one day,” Sid writes. They also want to help their son with postsecondary education.

“Is it feasible?” Sid asks.

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

What the expert says

Mr. Ardrey explores how things might unfold financially if Sid and Kamala buy the house they want early in 2021 for $880,000. For the down payment and the estimated $15,000 in purchase costs (land transfer tax, moving costs, legal costs and furnishings), they have more than $200,000 in cash equivalents sitting in non-registered investment accounts, Mr. Ardrey says. The remaining $680,000 would be financed by a mortgage.

To help with their mortgage payments, they plan on renting out the basement for the first 10 years, Mr. Ardrey says. They expect to get about $1,400 a month. The planner assumes taxes, utilities, insurance and maintenance add another $1,500 a month over and above the $3,220 mortgage payment. One third of these costs – plus a third of the mortgage interest – will be tax deductible as long as they are renting it out.

Sid is expecting to inherit $50,000 in a few years. When he does, they plan to travel to Africa at a cost of $10,000, depositing the remaining $40,000 in their tax-free savings accounts.

“Based on these numbers, and assuming no large increases in their income, the house purchase is only viable with the renter in place” at least until the couple retires in 2046 rather than the 10 years they are planning for, Mr. Ardrey says.

As for the child’s education, their registered education savings plan contributions of $210 a month will fall short, the planner says. With food and housing, each year at university is estimated to cost $20,000, rising at double the rate of inflation, or 4 per cent a year. “With their savings, they will be able to cover about half these costs,” he says. The remainder will have to be covered by loans, grants “or other means.”

When they retire at Sid’s age 60, he is estimated to get 75 per cent of the maximum Canada Pension Plan benefit he would otherwise be entitled to and Kamala 50 per cent. By the age of 65, both will have 40-plus years of residency in Canada, allowing for full Old Age Security payments.

Their investments have a historical rate of return of 4.95 per cent a year, with an average management expense ratio of one percentage point, for a net return of 3.95 per cent. After subtracting inflation, estimated at 2 per cent a year, they will have a real return of 1.95 per cent, Mr. Ardrey says.

“Based on the above assumptions, they just break even with their $48,000-a-year spending goal,” the planner says, “with no room for unforeseen expenses or emergencies.”

To improve their circumstances, the couple could buy a less expensive home. It could be a smaller one in their desired neighbourhood or one farther afield, making their commute to work longer. Either way, they would not likely be able to command such a high rent from the lower-level apartment, the planner says.

Instead, they might want to consider one or more of the following:

Increase their annual savings now through a forced savings program, but “this would be difficult to do when they are already pushed to the edge of their budget,” Mr. Ardrey says. Or they could plan on renting out the apartment throughout their retirement years. “This would allow a non-investment asset – their home – to generate income for them,” the planner says. “They need to decide if they want to continue to have someone in their home and if so, for how long.”

Alternatively, they could sell the house and downsize after they have retired from work. Or they could work longer or spend less when they retire, “not a preferable choice,” the planner says.

The best alternative, Mr. Ardrey says, would be to improve their investment strategy. They have multiple accounts at several different financial institutions. They should consolidate at one financial institution and develop a diversified strategy using exchange-traded funds, he says.

As their portfolio grows, they should look to move to an investment counselling firm that can offer private investments to supplement the couple’s diversified equity and fixed-income strategy. If all goes well, they should be able to increase their returns net of fees by about one percentage point, the planner says. This would give them more of a financial cushion without having to sacrifice their lifestyle.

One thing that could work in Sid and Kamala’s favour is the potential effect of COVID-19 on house prices. Canada Mortgage and Housing Corp. recently estimated that in a worst-case scenario, house prices could fall as much as 18 per cent over the next 12 months, which would knock $158,000 off the price of their desired home. “If that were to happen, it would certainly make their financial goals that much more achievable,” Mr. Ardrey says.

Client situation

The people: Sid, 34, Kamala, 29, and their toddler.

The problem: Can they afford to buy the house of their dreams?

The plan: Gain a solid understanding of the potential risks and trade-offs involved in buying the house they want.

The payoff: A greater potential for financial security.

Monthly net income: $5,900

Assets: Cash and cash equivalents $210,655; his RRSPs $45,425; his TFSAs $23,505; her RRSPs $3,760. Total: $283,345

Monthly outlays: Rent $1,900; home insurance $20; electricity $40; transportation $450; groceries $400; child care (grandparents are main caregivers) $100; clothing $25; charity $20; personal care $50; dining out $200; subscriptions $30; drugstore $20; cellphones $100; internet $45; RRSPs $700; RESP $210; TFSAs $425. Total: $4,735. Surplus of $1,165 goes to unallocated spending and saving for down payment.

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: Can this couple still retire in three years after their investments took a major hit?

0 Comments

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 April 10, 2020

Robert and Rachel have worked hard, raised three children and – thanks to high income and frugal living – amassed an impressive portfolio of dividend-paying stocks, which they manage themselves. When they approached Financial Facelift in February, their combined investments were worth about $2.7-million.

After the coronavirus tore through financial markets last month, their holdings tumbled to a little more than $1.8-million by late March, a drop of roughly $900,000, or 33 per cent. Markets have since bounced but are still well below their February highs.

“The recent market downturn caught us by surprise,” Robert acknowledges in an e-mail, “but we are hoping we can weather the storm.”

Robert, a self-employed consultant, is 57. Rachel, who works in management, is 52. Together they brought in about $285,000 last year, although Robert’s income prospects for this year are uncertain. They have three children, ranging in age from 9 to 19.

“We feel burned out,” Robert writes, “but we have no company pensions or other safety blankets. Can we retire now?”

Leading up to retirement, the couple want to do some renovations costing $100,000 and take up recreational flying, which they estimate will cost about $150,000. Their goal is to quit working in three years with a budget of $100,000 a year after tax. Can they still do it?

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

What the expert says

“The rapid decline and subsequent volatility of their investments is a result of how they are investing,” Mr. Ardrey says. Their portfolio is 85 per cent common stocks and 15 per cent preferred shares, the planner notes. “Of the common stock, about 90 per cent is Canadian. This lack of diversification in their investment strategy will affect their retirement plans.”

For the first quarter, major stock markets were down more than 20 per cent, he says. “The fixed-income universe in Canada was up 1.56 per cent for the quarter.” Having some fixed-income securities “would have mitigated the couple’s losses.”

In preparing his forecast, Mr. Ardrey weighs some different situations. He assumes their investment returns from this point forward equal the long-term average for this type of portfolio of 6.25 per cent. This rate of return continues until they retire from work in three-and-a-half years.

When Robert and Rachel retire, the planner assumes they reduce their exposure to stocks and switch to a balanced portfolio of 60 per cent stocks and 40 per cent bonds. This would give them a return of 4.5 per cent. “From there we can compare how much impact this market decline had on their portfolio.”

Their original $2.7-million would have given them a net worth at Rachel’s age 90 of $10-million, adjusted for inflation, including their residence and rental property valued at $5.4-million, Mr. Ardrey says. If they chose to spend all of their investments, leaving the real estate for their children, they could have increased their spending from $100,000 a year to $136,000, adjusted for inflation, giving them a comfortable buffer.

With their current portfolio – about $2.2-million as of April 6 – they would have a net worth of $8.4-million at Rachel’s age 90, including $5.4-million in real estate. They would have the option of increasing their spending to $118,000 a year. “This is half of their former buffer, which is a significant difference,” Mr. Ardrey says.

Even if the markets returned double the couple’s historical rate of return, or 12.5 per cent, from now until they retire, “it would still not make up all of the difference of what they have lost,” the planner says. Their net worth at Rachel’s age 90 would be $9.5-million and they could increase their spending to $130,000.

This market downturn speaks to the value of a balanced, diversified portfolio and professional money management, Mr. Ardrey says. “In so many cases, people try to invest on their own without truly understanding their ability to tolerate risk, or without a financial plan in place” to help them understand the implications of market returns on their retirement.

He recommends Robert and Rachel gradually shift to a professionally managed portfolio that includes both large-capitalization stocks with strong dividends, diversified geographically, and a fixed-income component comprising corporate and government bonds. This strategy could be supplemented with some private income funds – which do not trade on financial markets – to stabilize their returns and potentially enhance their income.

By making this change, they could increase their rate of return in retirement from 4.5 per cent to 5.5 per cent, giving them an additional financial cushion of $12,000 a year. “This would be especially beneficial if markets take a long time to return to their former highs,” Mr. Ardrey says.

The plan assumes Robert will get 85 per cent of Canada Pension Plan benefits and Rachel 75 per cent, starting at age 65. They will both get full Old Age Security benefits.

Fortunately, this couple have ample resources, including real estate, that they can use to insulate themselves against unexpected expenses, Mr. Ardrey says. Many other Canadians who have been investing in the same manner do not. Worse, many investors may have other financial stresses such as a lost job or mounting debts that could force them to liquidate their portfolio at an inopportune time, the planner says.

“What the past month has shown is that there are significant risks to do-it-yourself investing and not having a proper asset mix in place – especially as you approach retirement.”

Client situation

The people: Robert, 57, Rachel, 52, and their three children.

The problem: Can they retire in about three years without jeopardizing their financial security?

The plan: Retire as planned but take steps to draw up a proper financial plan that includes a more balanced investment strategy.

The payoff: Lowering potential investment risk to better achieve goals.

Monthly net income: $16,720

Assets: Cash $32,875; stocks $589,775; capital in his small business corporation $157,080; her TFSA $82,220; his TFSA $57,035; her RRSP $446,145; his RRSP $621,755; her locked-in retirement account from previous employer $76,405; his LIRA from previous employer $184,825; registered education savings plan $81,260; residence $1,800,000; recreational property $650,000. Total: $4.78-million

Monthly outlays: (including recreational property): Property tax $1,215; home insurance $125; utilities $495; maintenance $240; transportation $650; groceries $1,105; clothing $435; gifts $215; vacation, travel $325; dining out, entertainment $385; pets $45; sports, hobbies $625; piano lessons $160; other personal $415; doctors, dentists $200; prescriptions $70; phones, TV, internet $140; RRSPs $1,830; RESP $630; TFSA $915; savings to taxable accounts $7,460. Total: $17,680.

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
↓