For this Couple, the Hard Parts Done


In Toronto, a couple we'll call Boris and Stefanie feel that that they are in a financial dilemma. Their combined gross income of $200,000 a year is far above average. Yet they worry that they don't have much to show for it. They drive a couple of aging cars and live modestly.

Boris, a software executive, is 48 and Stefanie, who runs a consulting business from their home, is 47. At midlife, they fear that they may repeat past financial mistakes. They bought their $423,000 house a few years ago and think it has not appreciated. They remember the large losses they took in the tech bust of 2000.

Recently, Boris's company was sold. The sale will produce a cheque for $725,000. With this windfall has come the concern that the money not be squandered in a bad investment.

"Our financial philosophy to date has been to work hard to save hard," Boris explains. "But we need a solid financial plan to maximize our investments. Any mistakes like those in the past will definitely delay our retirement."

What our expert says:

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with the couple. "This case is about matching the couple with a portfolio that provides peace of mind and long-term security. In the past, their portfolio has caused them misery. Now they fear that mistakes could jeopardize their retirement," Mr. Moran said.

A foundation for a comfortable retirement is in place. Their assets, including their $423,000 house and a $200,000 cottage, total about $2-million. They have a small mortgage of $12,500 on their house.

Boris and Stefanie would like to retire in 10 years with a $60,000 after-tax income in 2007 dollars. It's feasible, but it will take careful investing.

Currently, the couple adds $2,500 a month to their registered retirement savings plans. If they can achieve a 6-per-cent nominal return and if inflation runs at an average 3 per cent a year, they would have $1,004,700 in 2007 dollars when they want to retire in 2017.

The couple also has $700,000 in non-registered cash. The income or other returns on this non-registered money will be subject to taxation as realized. If, after tax, Boris and Stefanie can generate a 6-per-cent return, then, allowing for 3-per-cent inflation, they could turn this capital into $940,000 by 2017. If, from the retirement date forward, funds produced the same 3-per-cent real return and if the couple spends the income and principal at a constant rate for the 33 years from beginning retirement to Stefanie's age 90, the couple could have $102,400 in 2007 dollars a year for living costs, Mr. Moran says.

Based on their work to date, at age 65, Boris will qualify for 94 per cent of maximum Canada Pension Plan benefits of $10,365 a year in 2007 dollars and Stefanie at age 65 will qualify for 81 per cent of benefits. At each partner's age 65, that works out to $9,745 a year for Boris and $8,396 a year for Stefanie, Mr. Moran estimates.

If they decide to take early benefits, they will give up 0.5 per cent a month for each month prior to age 65 at which they elect to begin benefits. Old Age Security will pay each partner $5,903 a year beginning at age 65. If they continue to save $2,500 a month and then decide to retire in just five years, they could have $74,700 a year in 2007 dollars before taxes for their lives, Mr. Moran says.

On an after-tax basis, this amount would exceed their $60,000 goal. They could have tax problems, however, because a good deal of their capital will come from sale of an asset in Boris's name. Attribution rules used by the Canada Revenue Agency say that the owner of an asset is responsible for resulting income.

However, the couple may also use a lending strategy. Boris can lend Stefanie money to invest. Stefanie will have to pay Boris interest at the CRA's prescribed rate each year, but the loan will put the fruits of lending into her hands. She can invest for income or growth and deduct the interest cost. She will probably be in a lower tax bracket than Boris.

There is no certainty, however, that Boris and Stefanie will invest well. Because of their experience in seeing a gain of nearly 300 per cent in a tech fund vanish in the 2000-2002 tech bust, they maintain large balances in their accounts in cash. They have nearly $634,000 in U.S. money market funds and bank balances and hold 77 per cent of their children's registered education savings plans in guaranteed investment certificates. Their taste for liquidity is costing them the potentially higher returns that are available in equities. On a short-term basis, holding cash provides insulation against market volatility. However, over periods of 10 or more years, the cost of that protection becomes evident in the far lower returns that cash generates.

Boris admits that he is not a sophisticated investor. He could employ a portfolio adviser on a fixed fee basis and save a large part of the fees he currently pays on his funds. If a professional manager charges 1 per cent a year on assets under management, the savings could be 1.4 per cent just on the RRSPs.

Should the couple choose to shift from high-fee funds to low-fee exchange-traded funds with management fees as a low as 30 basis points a year (one basis point is 1/100th of a percentage point), then the savings could be even higher, the planner notes. However, the couple should consult a portfolio manager in choosing ETFs or other investment assets, Mr. Moran emphasizes.

Boris and Stefanie also need to deal with various U.S. dollar holdings in several of their accounts. The greenback is trading near its three-decade low against the Canadian dollar as a result of both the decline of the American currency against other major world currencies and the strength of the loonie. It is difficult to predict future exchange rates. However there is a fair chance that at some time in future, the U.S. dollar will rise in value.

That could happen if world commodity prices slow their ascent or decline, for the value of the loonie is linked to resource prices, Mr. Moran notes. Investing in preparation for future moves of American currency would be one of the responsibilities of the portfolio manager, he adds.

"This is a case about two talented people who were naive enough about finance to trust the tech boom and who are still wincing from their losses," Mr. Moran says. "But they should be able to exceed their retirement income goals. They have done the hard part, which is earning the money and becoming virtually debt-free. Now they can relax and let time continue their work."

"This is good news," Boris says. "We know that we can achieve our retirement goals. We knew as soon as my company was sold that we would have to get advice on use of the proceeds. This report is a first step in that process."

Client situation

The Couple

Torontonians with substantial incomes are fearful of investing.

The Problem

Wincing from losses in the tech bubble, they hold huge amounts of cash.

The Plan

Diversify and get fee-efficient advice from a portfolio manager.

The Payoff

A comfortable retirement with fewer investment headaches along the way.

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