By Jasmine Miller
IE:Money
February/March 2003 Issue

Bob and Louise have a successful small dairy farm in New Brunswick, which they’d like to pass on to one of their children. That doesn’t mean, however, that their kids won’t have plenty of other options.

Bob Davie, 42, is the third generation to farm his family’s 300 acres complete with 25 to 30 milking cows. Because the farms such a small operation he’s able to work it by himself and, thanks to stable milk prices, he can count on a regular cheque from the provincial dairy board. Louise, 34, is an elementary school teacher who’s currently on maternity leave until April. The couple hopes that one of their children will want to carry on the family farming tradition. “Bob had to make that decision when he was about 24, when he was finishing university,” says Louise, who didn’t want to use her family’s real names. He moved into the farmhouse while his parents retired to a second house on the property. That’s how the Davies hope their own retirement will unfold, although if their children decide to pursue a different course, they could sell the property.

“We try to split everything down the middle, all our expenses, but it’s not a textbook split. It’s a partnership,” says Louise. She and her husband make the same income (when she is working full-time) but cover different expenses. They keep separate bank accounts and invest separately, too. “It’s working well,” says Louise. “I’m a good saver, but he’s better. I’m the spender of the savers. He’s very conservative with his investments and I’m aggressive.”

After working with a couple of financial advisors, Louise decided to look after her own portfolio. “The results were mediocre,” she says, although she may be underselling herself: “It was luck with timing. I sold a lot before December 2000, and we used the money to do some major renovations to the house.” Neither Louise nor her husband have revamped their portfolios as a result of the more recent market gyrations. “We did almost pull everything, but in the end we just sat tight.”

Louise and Bob admit that they’re still uneasy, however. “We keep pouring money in and we have no idea what’s happening with it,” says Louise. “We look at the statements and we’re not in control anymore. We have way too many funds.” Part of the reason for that is just life. “We were doing a good job tracking expenses and investments and keeping on top of things,” says Louise,” and then the kids came along.” The Davies have three children, ages six, three and six months.

“I learned about investing from my family, when an elderly relative gave me a whack of BMO stock,” says Louise. “The lessons learned were more valuable than the actual stocks.” As a child, tracking her portfolio was fun, something she did with her father. “All I did was take the monthly price and graph the ups and downs,” Louise remembers. “My dad would never have let me sell, he still complains if I talk about selling now, but the education was valuable, it got me interested in investing, and I plan to do that with my own kids.”

Louise’s full-time income is $55,000 a year and includes generous benefits: full medical and dental for the family, life insurance of $100,000, short- and long-term disability, and a pension plan. When she goes back to work full-time, child care expenses will be $6,000 a year. While Louise loves her work as an elementary teacher, she is considering returning only part-time. “I’d get to spend more time with my kids, and I could save money for the family. I would be able to shop more carefully if I was only part-time. When I’m full-time, I’m always on a dead run. If I was home more, I would prepare more food at home and cook better meals, too.”

Louise’s income, along with her pension benefits, would be cut in half is she went back part-time. She would also have reduced health benefits and although she would keep the life and long-term disability insurance, they would come with a price tag. She would, however, be able to cut her child care expenses in half, and while she would put fewer miles on her car commuting to the school she would still need it since the Davies live an hour from the nearest big town. Louise figures she’d need $100 a month in new clothes for work whether she’s full- or part-time since she still has some pregnancy weight to lose. She also estimates $80 a month in lunch money whether she’s logging 40 hours a week or 20. “I’m not sure what to do,” she says. “I’d like some advice on that.”

For her husband, the big question is disability: “If Bob were injured, are we in a good position or not?” asks Louise. Bob pays $1,000 a year for disability insurance, which will kick in 90 days after making a claim. But if Bob broke his leg or had an accident, what would the Davies do? “To do his job on a daily basis, Bob needs to be a hundred per cent,” says Louise. “I’m not sure if we are putting the money I the right place.” Would a different type of insurance serve the family better?

Louise wants to have another baby in the next couple of years, and while she doesn’t think that will affect their finances on a day-to-day basis, she is worried about RESPs. “Do we have the right investments and will it be enough? We have too many funds in our portfolio. There is a scholarship trust plan but we are contributing only $50 a month to that.”

Louise and her husband want to retire at 55. For Louise, her pension plan is the mainstay of her retirement-if she were to stop working now, after 12 years with the local school board, her pension would pay her $560 a month. Bob’s relying entirely on his RRSPs. “We have less than $100,000 between us,” says Louise. “Can we afford to retire at 55?”

The couple aren’t hurting for money, but they wonder if they have enough cash on hand. “If my husband couldn’t work, we would have to hire someone to replace him,” says Louise. Should the Davies build up their emergency fund or should they focus on their RRSPs?

Louise would also like to be able to track her investments, even if she goes back to working with an advisor. “Can your experts recommend a computer program for me?” she asks.

What the Advisor Recommends

Second Opinion
Adrian Mastracci, MBA, R.F.P., President KCM Wealth Management Inc., Vancouver

Bob and Louise should be congratulated for doing many things right, especially “paying themselves first” by making RRSP and RESP deposits and by being debt free. It is also commendable that Bob and Louise recognize the need to attend to their retirement planning needs. It is refreshing to see the responsible use of credit. This has kept them from incurring non-deductible loans. Bob and Louise’s expenditure pattern is not unusual at their stage of financial development. They are going through the expensive phase in the raising of three children.

To provide for the long term, Bob and Louise estimate that they will require $65,000 of gross annual income, in today’s terms, commencing at Bob’s age 55. Inflation is calculated at 3 percent per annum and return on investment is 6 percent per year. I also added five years to life expectancies for planning purposes and assumed Bob will be around for 41 more years and Louise for another 53 years. Accordingly, I estimate that Bob and Louise will require about $1,650,000 of investment assets at Bob’s age to 55 to generate the $65,000 income goal. This sum does not include the residence, teachers’ pension plan, CPP and OAS entitlements. Attaining this sum is probable as long as their investments earn 8.5 percent. A more realistic goal would be for Louise and Bob to move their retirement age to 60, when they would need a 5.9 percent return.

The current RRSP asset allocation is too heavy in equities. An overall allocation to equities in the 60 per cent area would be more prudent and reduce exposure to market volatility. The couple’s portfolio also contains too many mutual funds. One or two investment vehicles in each of the U.S., Canadian and global equity markets is more than ample. The current holdings are not as diversified as they think because the stocks overlap in the various mutual funds. If any of the mutual funds are being purchased on the deferred sales charge method, this practice should be stopped since it usually serves to cloud the investment decision. If no changes are made to the current holdings, then future RRSP contributions can be directed to income instruments, such as bonds or terms deposits, as a way of changing the asset mix.

The Davies should use spousal deposits to ensure that income draws during the retirement years are as equal as possible. This strategy translates into the least amount if income taxes for the family. The couple should also review the designation of beneficiary for each RRSP account, making sure they are the beneficiaries of each other’s account so that there is no probate process.

The RESP accounts are also too heavily dependent on the fortunes of mutual funds and close to 100 per cent in equities, which is too risky. A more appropriate allocation may be 75 per cent to equities and 25 per cent to fixed income. Where possible, the RESP contributions should be directed to a “family RESP plan.” This allows the income to be paid out to one or more children who attend post-secondary education. It also allows grandparents and any other family members to contribute capital. The maximum deposit is $4,000 per year, per child, from all sources. The lifetime amount is $42,000 per child. When the oldest child reaches 14, a more appropriate investment selection would be a ladder of investments maturing partially each year to coincide with the likely educational draws required for the children.

Bob and Louise may consider the RRSP their emergency fund. However, it should be looked upon as the last resort because withdrawals are taxable and cannot be replenished. Relying on credit cards and/or a line of credit to smooth out the expense roller coaster has drawbacks. It makes them vulnerable because the amount of credit can be reduced or denied with little notice. This is especially important if they were to have sustained reductions of business income. The Davies need to put in place a financial cushion of three to six months’ total family expenses to protect them from an unexpected turn of events, such as a prolonged disability, a business downturn and/or a reduction of incomes. This may be a simple savings account, which can be accessed quickly. They should always hold the emergency fund account at an institution where they have no borrowings.

To cover all the expenses that would come up if he were to die, Bob should buy about $150,000 to $250,000 of term life insurance. Bob and Louise may wish to review the benefits and availability of a critical illness policy. However, the risk of a long-term disability has a bigger financial impact for their situation and should be covered first.

Louise and Bob should also review the prospects for business interruption coverage in the event of a serious business loss. If there was a fire on the farm and all the buildings disappeared, even if the Davies saved the cows, they would be asking, “How do we get back on our feet?” A policy like this replaces in income stream in the event of such a loss. It may be too expensive for Louise and Bob, they may decide to should the risk themselves, but they should look into it.

FINANCIAL SNAPSHOT

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.