 |
 |
| Martha says, "I can see that things should work out in my favour and, with this analysis, I feel more confident about my financial future." |
By Andrew Allentuck
The Globe and Mail
Report on Business
Saturday, February 24, 2007
In Vancouver, a businesswoman we'll call Martha, who has two grown children, contemplates retirement in three to five years. At 60, her consulting company has $100,000 annual cash flow and good growth prospects. But with no company pension and only $474,000 in financial assets to finance decades of retirement, she wonders how she can afford to leave the business.
Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says, "Martha has several ways to boost her savings to the level required to fund her retirement. "
"I don't see how I can stop working at age 63, which is my real hope, or even at age 65, and still be able to afford even a modest lifestyle," Martha explains. "I would like to be able to spend several months of the year in warmer climes."
What our expert says
Facelift asked Adrian Mastracci, a portfolio manager and financial planner who heads KCM Wealth Management in Vancouver, to work with Martha in order to devise a way for her to retire.
There are good things and bad things in her situation, Mr. Mastracci says.
"The good thing is that she is an astute businesswoman with no debts. The bad thing is that she has too many investments to track. Her 38 stocks, four mutual funds, and five fixed-income deposits, plus cash in various places, don't seem to fit together. There is no investment plan and no evidence that she has thought through an asset allocation policy."
Martha would like to retire with $60,000 of gross annual income in 2007 dollars.
Her planning horizon is age 85, to which Mr. Mastracci has added five years to reduce the chance she might run out of money during her lifetime. Inflation is assumed to run at an average rate of 3 per cent a year and investments are assumed to generate an average annual compound return of 6 per cent.
Martha should receive 90 per cent of the maximum 2007 monthly Canada Pension Plan payout of $863.75 or $778 at age 65, he adds. She will also receive and retain Old Age Security payments in full. Currently, OAS pays $491.93 a month.
Together, her public pensions will pay her $1,269 a month or $15,239 a year. To achieve her $60,000 gross annual income target, she will need to generate $44,761 a year from her investments, he estimates.
Martha will need about $930,000 five years from now to produce that amount of pretax income, Mr. Mastracci calculates. He admits that is an aggressive goal. She has five years, at most, to add the required $456,000 to her current $474,000 financial assets. She can do it if she receives an expected $250,000 inheritance, downsizes her condo in order to capture value of about $100,000 and adds $9,000 a year to her registered retirement savings plan.
There is some room for flexibility in these estimates. If Martha can sell her business at a price of perhaps twice its annual income of $100,000, realizing $200,000, she could keep her present $500,000 condo or retire a year or two earlier than at age 65. But the projections are sensitive to inflation and rates of return on her investment portfolio, Mr. Mastracci explains.
If she does not receive her inheritance or cannot sell her business for close to $200,000, then Martha would have to add an unacceptable level of risk to her investments in order to achieve her target of $930,000 within the next five years, he notes.
There are a few other options for boosting savings to $930,000. Martha could sell her condo, get $500,000, which is its estimated value, and then rent. The short-term result would be an increase in cash flow, but she would be giving up a substantial asset and the likelihood that over the long term it would increase in value.
A three-decade-long planning period exposes Martha's retirement plan to many risks, Mr. Mastracci notes. Not only may asset prices and rates of return vary within a wide range, but also if inflation were to rise, she would have financial challenges.
An increase of just 1 per cent in the average annual rate of inflation would require that she add $130,000 to her capital, raising the target to $1,050,000 at age 65, he says. Uninsured health care costs could rise. There is a tradeoff between certainty, provided by health insurance and disability coverage, which she carries, and post-insurance cost income. At her age, Martha needs to be certain with conservative investment and insurance planning, he explains.
Martha has been a diligent saver. She should continue to use her RRSPs and add $9,000 for 2007. She could transfer a taxable asset to the RRSP and so obtain her tax relief at no cash cost.
Indeed, she has used asset transfers for several years to make RRSP contributions. Those transfers of assets in kind from taxable accounts produce short-term tax savings, but do not add to total annual savings. As her business improves and grows, Martha should add to total savings with funds not already invested. She should then adjust the mix of assets in her portfolio. She has no deferred-fee mutual funds, so she can sell them without penalty, Mr. Mastracci notes.
Martha should rebalance her portfolio to achieve a balance of 60-per-cent equities or stock mutual funds and 40-per-cent bonds or other sources of fixed income. In her rebalanced portfolio, 30 per cent of assets should be Canadian stocks or funds, 20 per cent U.S. stocks or funds and 10 per cent global stocks or funds. Then 30 per cent of total assets should be laddered out to five years and 10 per cent should be in stocks with a record of paying strong and rising dividends. Martha should select mutual funds with management fees of 1.75 per cent a year or less, the planner suggests.
Martha's business is new and its returns are growing. If it prospers and is able to generate additional income of $20,000 a year, pushing her gross income to $100,000 a year, it will enable her to retire as she plans, improve her prospects for selling the company, and ensure that she has a comfortable retirement.
If things do not go well, Martha may have to work part time to age 68. By then, the $500 a month she pays to one of her two children for educational expenses should have ended, adding a potential $6,000 a year to her income. The chances of a good outcome exceed those of a bad outcome, Mr. Mastracci says, but the long time horizon for Martha's retirement implies a need for continuing asset management, he says.
"It is clear that Martha has not achieved the financial certainty that would go along with a well-established business and enough financial assets to guarantee her target retirement income," Mr. Mastracci says. "But she has several ways to boost her savings to the level required to fund her retirement. If she gets her inheritance or can sell her business profitably, or even downsize her condo to squeeze out six figures, she can have the retirement income she wants. I think the odds that she can make this happen are good. She is a resourceful and astute person with an incentive to realize her hopes."
"I was terrified that I would end up eating cat food," Martha says. "But this report makes me think that won't be necessary. I can see that things should work out in my favour and, with this analysis, I feel more confident about my financial future."
Client situation
Martha, 60, lives in Vancouver.
Net monthly income: $5,000.
Assets: RRSP $249,400; taxable investments $207,300; cash $17,200; condo $500,000; personal property $100,000.
Total: $1,073,900.
Monthly expenses: Property taxes $300; utilities & phone $155; condo fees $450; food, dining out $375; clothing $350; educational fees for child $500; fuel, repairs for car $275; car insurance $100; home insurance $30; health insurance $225; charity and gifts $200; sports & health care $300; grooming $225; taxi and transit $25; travel $300; miscellaneous $400; savings, $790.
Total: $5,000.
Liabilities: None. |
