In Victoria, a couple we'll call Henry and Theresa insist that their investments be socially responsible. At their respective ages of 39 and 37, they work for units of the B.C. government and have advanced degrees, though little knowledge of capital markets.
Over the years, they have entrusted their money to mutual funds and money managers linked to what they have insisted be ethical investing. They have put their social principles ahead of asset selection, with what have turned out to be mostly below average returns by the majority of their mutual funds, which they have used for their registered retirement savings plans and their two children's registered education savings plans.
What our expert says:
Facelift asked Derek Moran, president of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Henry and Theresa in order to determine why their portfolio has been a disappointment. He says their mission to own only what they consider socially responsible companies is now a cost.
On a current cash flow basis, Henry and Theresa and their children ages seven and three, are doing well. The parents' gross income, $128,000, supports the family's rather modest expenses. Their house, for which they paid $565,000 in 2004, has an estimated value of $800,000. Their $305,000 mortgage leaves them with $495,000 equity in their house.
They have $115,400 in various mutual funds, $5,200 in RESPs and a modest car. They live relatively simply, but the savings they have invested in ethical funds have been evaporating. The worst is an investment in a labour-sponsored venture capital fund.
Established in 2001, the LSVCF account has produced returns for the period that have averaged between a 4-per-cent annual loss and a 4-per-cent annual gain. Those returns are about average for the sector, which features risky microcap investing in companies that have not gone public, high fees, and the requirement to hold units for seven years. From an investment perspective, LSVCFs have been a flop, Mr. Moran notes.
Henry and Theresa have done better with investments established 10 years ago in a fairly conventional Canadian equity fund that is one of the many holdings in their portfolio. It has produced strong, double-digit returns for each complete calendar year since Henry and Theresa bought it for their RRSP and RESP portfolios. But their ethically sensitive funds, which are the majority of their portfolios, have underperformed the S&P/TSX composite index. Ironically, several of those funds have charged annual management fees far higher than average for mutual funds that do not advertise their conformity to ethical investment standards.
Henry and Theresa have borne the costs of socially conscious investing, but they do not need to save for retirement, Mr. Moran notes. If they stay with their careers for 30 years, which they are on track to do, then by the time they are in their mid to late 50s, they will each have a defined benefit pension plan and will have qualified for close to peak Canada Pension Plan benefits. They will have paid for their house, their children will have established lives of their own and their disposable income will have risen in real terms, the planner says.
Those defined benefit pension plans are fairly generous. Assuming that each partner works 30 years and that their salaries only pace inflation, they will each receive 2 per cent of 30 years, times the best five years of their salaries. That works out to $36,000 in 2007 dollars for each partner. The pensions are not guaranteed to be indexed, but are likely to be if actuaries deem funds for indexation to be available. Moreover, the pension plans have never failed to match inflation.
Each partner will qualify for what is likely to be close to the maximum CPP payout of $10,365 less a reduction of 0.5 per cent for each month prior to age 65 that benefits begin. For each partner, that amounts to $7,256 each in 2007 dollars if taken at age 60, which is likely under the circumstances. Each will also qualify for full Old Age Security of $5,903 a year. The total of all pensions will be $98,318 before taxes.
RRSP savings will add to the couple's retirement income. Predicting returns for the couple's savings is difficult. However, if one assumes that their RRSPs will grow at 6 per cent a year and that inflation will run at 3 per cent a year, then even if they contribute nothing more to their RRSPs, they will have $208,425 in 20 years in 2007 dollars.
If the couple were to boost returns with a new and more profit-oriented investment strategy for their RRSPs, or continue to save for their retirement in these plans, then they might run into the Old Age Security Clawback, which begins in 2007 at $63,511 of individual net income. For that reason, it would be useful to consider withdrawing RRSP assets before OAS begins.
Instead, Henry and Theresa could also put the $250 a month into their children's RESPs. If they add $250 a month, they will have annual contributions of $3,000. The Canada Education Savings Grant will add $600 to this sum each year. If the RESP grows at $3,600 a year with a 3-per-cent real rate of return, then by the time their seven-year-old is 17, the fund will have a total of $48,258 in 2007 dollars. The 17-year-old can begin drawing while the parents can continue to add money until their younger child reaches 17, Mr. Moran says.
Henry and Theresa can also put their minds to the task of individual stock selection, Mr. Moran suggests. Rather than entrust their money to managers selected first for ethical conformity to their own standards, they can seek out companies for investment potential and then filter out those that do not meet their social criteria. That way, they can build a portfolio of companies that meet their requirements for a return in the form of potential for capital appreciation, dividends and diversification, and that have desirable social practices.
"Until now, this couple have put their ethical standards ahead of their investment plans. That is putting the cart before the horse. They should seek investments and pass them through their ethical filter. The result will be the same or even better if they do their own selection, Mr. Moran says.
"We are happy to pay a price for making green investments, but we realize that there is a threshold that we don't want to cross. We don't want to lose money when we invest for our children," Theresa says. "We are going to study investments on our own. We think we can do better than the investment funds have done for us."
Henry, 39, and Theresa, 37, live in Victoria with their children ages seven and three.
Net Monthly Income
RRSPs $115,400, RESPs $5,200.
Mortgage $2,632, property tax $365, food $1,000, dining out $260, entertainment $125, clothing $240, activity fees $620, RRSP savings $250, RESP savings $200, car fuel & repairs $188, vacations $300, car & home insurance $170, charity & gifts $100, savings $150.
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