Anti Investor Heading Into Savings Abyss
In B.C.’s lower mainland, a 54-year-old woman we’ll call Emma makes her living providing consulting services to fancy B&Bs. Her specialty is amenities — how much management can charge for rooms with fine toiletries and breakfasts with lavish buffets. But in her own life, such refined measurements of financial value are absent. Emma lacks the tools to manage money and rejects the idea completely that she should learn them.
“I am not interested in amassing money,” she says. “It is not something about which I care.” Emma contends that the only business in which she should invest is her own. “No one can make me buy stocks in any company that I do not own,” she declares. “I do not know the difference between stocks and bonds because I have no interest in that stuff."
But stonewalling is a poor strategy for her retirement. If Emma does not change her attitude toward investing in diversified assets, she faces a subsistence existence after a lifetime of work. This is not how it has to be. Some appreciation for the rewards as well as the risks of capital markets is essential. It is one thing to fear investing or not trust a financial advisor, it is another thing to sabotage your old age.
Emma’s business has slumped in recent years, with cash flow down about 60%. She spends more than what she has coming in, depleting her $7,740 cash savings in the process. At her current rate, her savings account will be obliterated in three years. Recognizing that she is heading into an abyss, she asked Family Finance for guidance.
“I would like some help with planning for retirement,” Emma says. “I enjoy my work and can probably carry on for years, but will I have enough to retire?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Emma. “She trusts no investments other than real estate,” he says. “But she is only 54, so there is time for a rescue plan.”
Emma is paying off mortgages on her house and a condo rental unit — a total of $1,871 a month. Add line-of-credit interest for other debts, property taxes and condo fees, a total of $1,033 a month, and her debt and real estate commitments eat up 64% of her $4,560 take-home income.
Pumping money into the rental-unit has cost Emma lost opportunities to use other investment devices which she disdains. “I do not trust mutual funds or financial managers,” she says.
If Emma keeps her rental property to age 65, her mortgage will be down to $87,650 from $179,000 today, assuming she continues to pay her present rate of 2.40%. She could sell the property, invest her realized equity of about $149,000 less selling costs for proceeds of perhaps $140,000 and invest in assets with higher yield and liquidity, such as large-cap dividend-paying stocks. She could put some money into a diversified real estate investment trust with a 5.0% to 7.0% yield to maintain some rental property exposure. The return of this portfolio could be 4% after the dividend tax credit is applied. Additional growth of 2% per year from capital gains could add to total returns.
Emma should look at retirement at age 65, when she will be eligible for Old Age Security. She will have been resident in Canada for 29 years out of the 40 needed for full benefits, currently $6,540 a year. Her OAS would therefore be $4,774 a year. She should be eligible for 50% of maximum Canada Pension Plan benefits, currently $11,840 a year, or $5,920 a year. Her condo rental income would be $300 a month, or $3,600 a year, if she does not raise rents. An RRSP, all GICs, would perhaps earn $550 a year at 2% interest before tax. Her annual total income at age 65 would be $14,844.
The Guaranteed Income Supplement would provide $70 a month and accelerate her OAS payments to full value for monthly income of $615, or $7,380 a year. That would bring her adjusted annual retirement income up to $17,450, a modest sum.
She could move into her condo, sell her $476,000 house, pay off the $137,411 mortgage and have $338,589 of equity before selling costs. If those costs are 5%, she would have about $321,660 to invest. If she were to get 4% after inflation from dividend-paying Canadian large-cap stocks on that sum, she would add about $13,000 to yearly income. She would lose the Guaranteed Income Supplement and the OAS boost. Her income on this basis would be about $27,844 a year before tax. She could skip paying property taxes until the sale of her condo, a B.C. seniors’ provision, thus saving $2,400 a year (or $2,700 before tax). That would make her total final income about $30,544 a year, or approximately $2,550 a month.
Assuming that she choose to live in the condo and no longer paid her house mortgage and its property taxes, her expenses would be $3,409 a month.
Emma should sell either the condo or her residence and grow her equity between now and retirement, Mr. Moran suggests. If she sells the condo, she loses its rent. If she sells her house, she cuts her largest single cost of living.
Emma’s future is grim unless she can raise her current income. She also needs to reduce the risk in her portfolio, which is almost totally committed to one asset class, property, in one pricey market, the lower mainland, where the capital gains she hopes for are uncertain. She must diversify into other asset classes and study investing or the records of managers who might handle her money, Mr. Moran says.
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