Destination: Retirement

Andrew Allentuck
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Funding a dream takes the right investment strategy before leaving the workforce Travelling the world is a retirement dream for many people, but funding it requires having the right investment strategy in place before leaving the workforce. Every penny counts when you’re ot actively employed so avoiding fees and clawbacks becomes even more important. Those are the issues facing Alec Braun, 59, and his wife, Marjorie, 56, (not their real names). They are psychologically ready to retire now, but have they done enough to build an adequate nest egg?

The Brauns seem to have done many things right since moving to Canada from Africa 15 years ago. Arriving with limited cash, $200,000 in assets and two children, they now have $1.6 million in total assets, including a mortgage-free home worth $900,000, no liabilities and their children are all grown up. Alec, a manager for a manufacturing company, and Marjorie, an administrator at a data processing business, have a combined annual income of $147,287 and accumulated financial assets of $644,460. Alec also has a defined-benefit pension plan that will pay between $2,114 and $3,751 er month, depending on when he retires, and the couple will receive some Canada Pension Plan benefits and a fraction of Old Age Security benefits. Yet the couple still wonder if all that will be enough. “Can we afford to retire?” Alec asks. “If we do not have enough money now, when will we? Will we have to sell our house? And how should we be investing our cash?”

Their chief problem is figuring out if their retirement plans match their accumulating wealth. They have been spending $8,400 per year on travel, some of it back to Africa, but they might spend more in retirement and in good health. They have in mind a nomadic lifestyle, travelling by RV and taking longer trips to South America.

They want to stay in Alberta, but perhaps downsize their 3,000-square-foot house. “We don’t think we will be away from our Canadian home a great deal of time,” Marjorie says. “But we really want to know how much time we can afford and how well we can live when we are away. That is going to depend not only on our pensions, but also on how well our investments hold up.”

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What the Experts Say

Assuming that Alec and Marjorie Braun retire early this year, they would receive Alec’s work pension of $25,368 per year plus a bridge to age 65 of $2,160 per year. The pension is not indexed to inflation, but it has a 100% survivor benefit that Alec chose so that if he predeceases Marjorie, the pension would not decline. Since the couple emigrated to Canada in 1997, they are only entitled to 15 years’ worth of CPP benefits: Alec would get $4,240 per year and Marjorie would receive $3,601 per year (in 2011 dollars). At age 65 in 2019, the couple will have been in Canada for 20 years, so they would each be able to receive Old Age Security benefits of half the $6,456 current full benefit..

In preparation for retirement, the couple plans to sell their home and realize perhaps $350,000 in cash. They would then have almost $1 million in financial assets. If this sum grows at 3% per year over the rate of inflation and they spend the income and principal completely by the time Marjorie is 90, they could withdraw $47,890 per year, estimates financial planner Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. All told, the Brauns would have a total annual income of $75,417 between now and when Alec is 65.

When both Alec and Marjorie are 65, the pension bridge will disappear, but CPP and OAS benefits will kick in. At this point, their total income would increase to $87,555 per year. By splitting Alec’s pension income, they would avoid the OAS clawback that currently begins at $67,668 per person. Assuming they pay income tax at an average rate of 20%, they would have $70,044 to spend each year, which is more than the $60,418 they currently spend (excluding RRSP contributions and other savings). Their standard of living would not decline in retirement, Moran concludes. 

“From coming to Canada with his wife and two children and not really a great deal of money to achieving a comfortable life with the prospect of a secure retirement, all in 15 years, is quite a remarkable story,” Moran says. “They have shown incredible saving discipline and have been rewarded.” There is, however, a potential problem with their investments, which will constitute 55% of their total retirement income at age 65. In a volatile investment climate, it is essential to ensure this income is resilient and that they keep what they earn.

On the surface, the Brauns’ portfolio looks good. The company-sponsored part of their invested assets are with respected institutional money managers such as Jarislowsky Fraser Ltd. and Montrusco Bolton. The management fees they pay in their group-sponsored RRSP are far lower than the typical 2.5% of net asset value. These funds hold durable Canadian large-cap stocks as well as some small caps that could add higher long-term growth. In their non-company linked mutual funds, which are the largest part of their portfolio, there are 13 different funds from one well-known company, mostly in stocks, with no significant direct exposure to bonds.

Though the world bond market is distressed at present, with many bank and insurance issues presenting far too much risk for a conservative retirement portfolio, putting some of the $230,000 currently in cash into short-term Government of Canada bonds and a diversified portfolio of investment-grade Canadian corporate bonds would likely reduce volatility and add to income, says Graeme Egan, a portfolio manager with KCM Wealth Management Inc. in Vancouver. Further, the bond component could be covered by a mutual fund with fees well below 1% per year of net asset value or an exchange-traded fund (ETF) with fees less than half that.

A bigger issue is that within the couple’s portfolio, there are several sector funds that have higher-than-average management fees and a tendency to be more volatile than the overall market. Adding sector funds to broad market stock funds tends to duplicate holdings. But sector funds, such as the couple’s global science and technology fund and global infrastructure fund, also eschew broad market funds that have mandates to seek return in balance with risk. If the resulting skews work, the portfolio gains. But the strategy typically adds extra management risk and higher fees. 

Alec and Marjorie have been offered a choice of switching their grab bag of funds into a balanced portfolio: 60% stocks, 30% fixed-income assets and 10% real estate assets. A move to this kind of structured fund, actually a fund of funds, would be acceptable if the fund company agrees not to charge backloaded penalties for switching and if the Brauns can get a no-load fee purchase option as well as a fee rebate to cut their management costs. They should also open Tax-Free Savings Accounts, which they have so far put off because they haven’t seen any prospects for capital gains that would make the accounts useful.

If Alec and Marjorie want to save even more on fees, they could assume portfolio management themselves and replicate the structure of the fund of funds in question using ETFs. Sector selection is far more important than specific stock or bond picking. ETFs balanced in the 60/30/10 ratio above might have fees as low as 0.4% per year, which would return at least another 2% into the couple’s pocket and ought to be considered, Egan says.

If running their own portfolio of ETFs and rebalancing from time to time doesn’t appeal to the couple, they could hire a portfolio manager for a typical fee of 1% of assets under management. If they choose this option, they would have to research managers and the services they offer. Their portfolio could outperform ETFs with a skilled manager or, with bad luck, lag the index returns that almost all ETFs replicate. But they would have a structural advantage in starting fresh without any baggage from past choices, good or bad. There also wouldn’t be any accrued capital gains (or losses) in funds that might one day come into income. Personal asset management is a tailor-made solution they can afford if they want it.

Stock and bond prices fluctuate, but savings on management fees can be a cushion when markets are down, Egan says. “Saving on fees and building income with dividend-paying stocks and secure, interest-paying bonds will make their portfolio more resilient and will tend to be a form of insurance for their retirement.”

(C) 2012 The Financial Post, Used by Permission