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By Andrew Allentuck
The Globe And Mail
Report on Business
Saturday, August 12, 2006
In Canmore, Alta., a couple we'll call Charles and Elizabeth, both 39, wonder if they should call it quits with mutual funds that have done little more than produce tax deductions. They are considering investing in properties.
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, “The goal is to reduce investment costs from current levels. If they do all of that and attain a nominal 6-per-cent return, they can attain their retirement income goal.”
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| "I am disappointed but not surprised that the planner says we have to work to age 65. But we are still relatively young and we have time to take risks with our investments." |
"My parents did well in mutual funds, but their plan has not been successful for us," Charles explains. "We have no returns worth mentioning; our funds are worth the same as what I bought them for. Our greatest returns have been on our home, so we are thinking of investing in real estate."
Charles, a business manager, and Elizabeth, an office supervisor, figure that they could buy into the Canmore market where, they say, prices have risen at a compound rate of 15 per cent a year for the past six years. They have no experience with real estate speculation, but they are aware of the problem of carrying costs. Canmore rents lag property prices, making it hard to cover mortgage and other carrying costs. They like Fort McMurray's market where costs of purchase are similar, but rents of as much as $3,000 a month for a two bedroom apartment would generate substantial cash flow after carrying costs. In any case, they would find it hard to raise the down payments for properties in either market without remortgaging their house, worth, they say, $375,000 (with a $124,000 mortgage).
What our expert says
"Charles and Elizabeth have a good sense of the speculative problems of investing in property, but they don't understand the larger issues of their finances," explains Adrian Mastracci, investment counsel at KCM Wealth Management in Vancouver. Analyzing the couple's finances for Facelift, Mr. Mastracci, a registered financial planner, says Charles and Elizabeth need to see their investment strategy in terms of their plans to educate their children, ages 15 and one, and to plan their own retirements. They're looking at 55 as a potential age for retirement and $70,000 a year in 2006 dollars as the gross income they would like in that retirement. Their disappointing returns in mutual funds have cast doubts on these plans.
They should be able to do better. At age 65, in inflation adjusted dollars growing at 3 per cent a year, Charles and Elizabeth should have $942,752 in 2006 dollars or $1,685,456 in 2032 dollars. That would produce a revenue stream for the next 23 years -- until Elizabeth is 88 -- of $55,663. Adding in Old Age Security and Canada Pension Plan would get them to their $70,000 target, Mr. Mastracci says. If the couple were to divert their current $908-a-month mortgage payments to their registered retirement savings plans, then, after their mortgage is paid up in another 13 years, they would have built up an additional $59,584, assuming 3-per-cent real growth into their savings. That would enable them to retire at age 60, the planner adds.
At age 65, assuming inflation runs at 2 per cent a year, Charles will receive annual CPP payments of $10,100 and Elizabeth of $7,070, both in 2006 dollars. If they have CPP split their accounts equally, each will receive annual payments of $8,585 in 2006 dollars or $13,010 in 2032 dollars.
Each will also receive annual OAS payments of $5,800 in 2006 dollars or $9,700 in 2032 dollars. There will be no clawback, which currently begins at net income of $62,144. By the time they are 65, the clawback threshold will have risen to an estimated $104,000 net annual income, assuming 2-per-cent annual inflation, Mr. Mastracci explains.
Thus by age 65 or perhaps a few years earlier if they put their mortgage money into their investments after their house is paid up, the couple can meet their retirement goal of $70,000 annual income in 2006 dollars. They can use a disciplined savings and investment plan and have some control over their risks or get in on the real estate boom by making speculative investments.
Getting cash for down payments and financing the mortgages, taxes and other costs of ownership would make it difficult to achieve the savings rate required to build up the asset base within their RRSPs that their retirements will require. They would find it harder to pay off their current $124,000 mortgage. They also need to put $4,000 a year into a group registered education savings plan for their two children in order to reap the $400-a-year Canada Education Savings Grant that provides a 20-per-cent boost to RESP savings up to the $2,000 per child limit.
Real estate does not qualify for RRSP investment except through the backdoor of investing in one's own home through the Home Buyers' Plan. Not only that, but the couple has already used and paid back an HBP loan. As well, putting substantial sums into speculative real estate could cripple their RRSPs' planned growth, Mr. Mastracci says. Of course, if Charles and Elizabeth were to be fortunate in their real estate ventures, they could easily beat the returns of the stocks and bonds in which most mutual funds are invested.
The couple has a collection of 29 mutual funds in their RRSPs that are back-loaded with annual management fees of as much as 3 per cent. A decade of 3-per-cent fees will take nearly a third of their capital if there is no gain in underlying asset values. Although some gains are likely, they have to realize fees are certain, returns are not.
Charles and Elizabeth should therefore migrate out of their large number of high-fee funds as soon as the backload penalties for cashing out too soon drop to zero or close to it. Indeed, for most of their funds, the penalty period is past. Mr. Mastracci suggests that the new portfolio should have no more than 10 funds with lower costs. It should blend index mutual funds with fees that average 1 per cent a year or less and exchange-traded funds with fees of 0.5 per cent a year or less.
Their RESPs should receive contributions of $333 a month, double their current rate of RESP saving, Mr. Mastracci suggests. This will make, at most, $17,000 available to their son, now age 15, when he begins post secondary education in three years and $44,919 available for their daughter, age one, when she begins post secondary education in 17 years. They should emphasize contributions to the 15-year-old's education first and then focus on their younger child once she enters post secondary education. The family's $9,400 of RESPs will not provide the 15-year-old with the same financial resources that will be available to the infant.
"This couple is becoming more aware of the costs of investments," Mr. Mastracci says. "They should focus on the management fees and deferred sales charges that they have been paying. The goal is to reduce investment costs from current levels. If they do all of that and attain a nominal 6-per-cent return, they can attain their retirement income goal."
"I am disappointed but not surprised that the planner says we have to work to age 65," Elizabeth says. "But we are still relatively young and we have time to take risks with our investments. We would be willing to take some of the growth in the value of our house and put that into a down payment and buy into Canmore real estate. After all, if you can't do this when you are young, when can you?"
Client situation
Charles and Elizabeth, both 39, live in Alberta with their two children ages 15 and one.
Net monthly income: After Elizabeth returns to work, $6,571.
Assets: House, $375,000; RRSPs, $172,600; RESP, $9,400; car, $4,000.
Monthly expenses: Mortgage, $908; condo fees, $160; property tax, $128; home insurance, $19; food, $800; entertainment, $450; child care, $900; RRSP savings, $1,180; RESP, $170; car fuel, repairs, $400; car insurance, $76; clothing, $300; charity, gifts, $90; savings, $990.
Total: $6,571.
Liabilities: Mortgage, $124,000.
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