Driven to Despair by Falling Portfolio Values


Andrew Allentuck

In B.C., a man we'll call Louis, 63, has been forced into retirement by a downsizing of his former job. Before that, he had an annual salary of $80,000. Now he coasts on pension income of $16,620 a year plus Canada Pension Plan benefits of $9,456 a year. His wife, who we'll call Elizabeth, 62, remains at an administrative job, pulling down a salary of $75,270 a year before tax plus early Canada Pension Plan benefits of $6,228 a year. They have income from investments of about $10,000 per year. That gives them pre-tax annual income of $117,574 a year.

They will be able to take income from $608,500 of taxable, RRSP and TFSA investments. A project to build a rental cottage that can bring in perhaps $25,000 a year before expenses is underway. The live in a $950,000 house with no mortgage, have two cars and a small boat. Poor they are not, but the life they have now does not match the one they had before Louis was dismissed. They cannot see the future.

Louis, looking to the past, is dismayed. "My wife would like to retire, but we can't manage without her income at this point," he says. "I do not know what chance I have of getting employment at my age. I would like us both to retire, to be able to eat out at will and not to have to worry about how to make ends meet."

His disappointment is compounded by losses he took in the stock market crash of 2008-2009. His investment portfolio lost 60% in the harrowing months of the meltdown. It went from a high of $840,000 to a low of $340,000, a staggering drop. It remains 25% below its peak.

In fact, the couple is getting by easily, spending just $38,856 a year net of RRSP, TFSA and other savings. Elizabeth can work a few more years to age 65, then collect $7,848 a year from an indexed pension plan. Both will be eligible for Old Age Security that currently pays $6,322 per person a year. Their RRSPs and TFSAs will pay $38,000 a year based on current asset values and a 4% rate of return over inflation.

Family Finance asked Derek Moran, a registered financial planner who heads Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Louis and Elizabeth.

The goal: Raise income from investments, reduce anxiety and cut tax exposure.

"They will have more income than they are spending when they retire." he says.

How the problem began

Louis built a stock portfolio of both solid large caps, including chartered banks and best-of-breed life insurance companies, and a few not-so-solid small caps. He took a major loss on energy producer Opti Canada, which has tumbled 90% in the past year to 19¢ a share. Another company they bought that makes diagnostic tests for cancer is worth 1¢ a share. These portfolio disasters are not so much the result of the market downturn as of company-specific issues.

Worse for the portfolio is an evident absence of bonds. When world markets crashed in mid- and late 2008, government bonds soared as investors rushed to the safest of havens. Had the portfolio carried a significant weighting of government and perhaps high-grade corporate bonds, paper losses would have been far less, Mr. Moran notes.

Driven to despair by falling portfolio values and the layoff, Louis sought advice.

Told to make an early application for Canada Pension Plan benefits at what was then a 30% reduction in age 65 benefits, he and Elizabeth cashed in. He accepted a lifetime reduction of CPP benefits, which is ironic given that men in his family have lived into their nineties. Adding to the problem, he and Elizabeth split benefits. The concept of taking income from a higher-earning spouse and transferring it to the lower earner to save tax had the perverse outcome of doing the opposite, for Louis is the lower earner. He effectively shifted income from his low bracket of 20.06% to his wife's bracket as high as 32.5%. The problem will moderate when Elizabeth retires.

Making changes

Louis and Elizabeth have a problem as much rooted in perspective and their fear of future losses as in asset values. They have no debts. They have a house worth almost $1-million that could, in a pinch, be downsized. The house and their $608,500 of financial assets plus the theoretical capital value of their civil service pensions, perhaps $500,000, gives them what could be considered $2-million of capital, though they cannot actually bank the capital behind government pensions. Poor they are not, but troubled they remain.

Peace of mind is precious, but Louis and Elizabeth are unlikely to have it while they tussle with their portfolio of successful ideas and collapsed hopes. They should consider hiring a professional portfolio manager for an annual fee of perhaps 1.0% to 1.5% of their portfolio's net asset value.

The portfolio needs to be restructured to 30% to 40% fixed income in the form of corporate bonds. Investing in corporate bonds is a discipline different from stock trading. Louis will need to study balance sheets and bond covenants. In this specialized market, if they decline to use professional management, the couple could use a managed bond fund with fees below 1% of net asset value. Low-fee bond exchange-traded funds would be worth consideration, Mr. Moran says.

Louis and Elizabeth want to pass on their house to their children, both in their thirties. They should discuss with a lawyer the use of a joint-partner trust to hold the house. The trust could continue to qualify for the tax-free exemption on sale of a principal residence and allow Louis and Elizabeth to obtain homeowner tax reductions, Mr. Moran explains. People over 65 who transfer assets to a joint-partner trust pay no capital gains tax on the transfer, he adds.

When both Louis and Elizabeth are 65, they will have estimated annual pre-tax income of $104,589 if they can generate investment income 3% above the rate of inflation or $108,850 if they can generate investment income 4% above the rate of inflation, all in 2011 dollars, Mr. Moran estimates. Half their income will be in the form of indexed pensions, CPP and OAS. With pension splitting, they will not be affected by the OAS clawback. Assuming they pay an average tax rate of 20%, they would have after-tax annual income of $83,671 in the former case or $87,080 in the latter. Their living expenses, a little less than $39,000 once savings are removed, are far below these conservative income projections. With the added stability of bond income and the increased amount of income, they can build savings and rebuild their portfolio.

"This is not so much a financial story as it is a tale of expectations and disappointments," Mr. Moran says. "We usually suggest that people be better managers of their money. In this case, we think Louis and Elizabeth should separate themselves from it by hiring a professional manager. The object is to sleep well. The plan is to look forward rather than back."

(C) 2011 The Financial Post, Used by Permission