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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, December 6, 2008
In Toronto, a woman we'll call Henrietta is 71. The retiree has two grown children, one grandchild and an active life with occasional foreign travel.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, “Conservative investing has to remain the cornerstone.”
With $620,200 in financial assets and a $700,000 house, she ought to feel secure. Her annual income target is $40,000 before tax in 2008 dollars. She currently earns more than that, but worries that the swooning market will turn her prosperity into poverty.
"I thought I would be able to live comfortably, but I am concerned," Henrietta says. "Will I have enough to live on or is there a way, perhaps a reverse mortgage, to access the capital in my house?"
WHAT OUR EXPERT SAYS
Facelift asked fee-only portfolio manager and financial planner Adrian Mastracci, head of KCM Wealth Management Inc. in Vancouver, to work with Henrietta. "This is a case of anxiety that exceeds circumstance," he notes. His advice: Stay with diversified stocks, income trusts and bonds, but increase bond holdings over the next decade.
Henrietta already has a good deal of financial security. Her gross annual income consists of $6,204 of Old Age Security payments, $5,030 of Canada Pension Plan benefits, $19,350 of registered retirement income fund withdrawals, $1,100 from an employment pension and $12,800 of investment income. The total: $44,484.
It is understandable that Henrietta feels anxious about the stock market, the planner says. The S&P/TSX total return index lost 31.4 per cent of its value in the year Oct. 31. No sectors of the market were spared. Income trusts were down an average of 19.4 per cent and Canadian equity mutual funds shed 33 per cent.
Henrietta has a diversified portfolio of quality financial assets, including bonds that will mature over the next four years. Her mix is 50 per cent stocks and 50 per cent fixed income - reasonable for average market conditions. But her cash flow could be in peril if stock dividends decline in the recession and government bond yields continue to fall, as they have in recent months.
Henrietta could try to trade her way to higher income, buying what appear to be deeply discounted financial stocks that have paid rising dividends for decades. But it is a risky play for a retiree who may have difficulty replacing money that could be lost if prices of shares of banks and other financial service companies continue falling. Rather than gambling on stock trends, Henrietta should consider alternatives to stocks, the planner says. The first option: Buy an annuity.
Annuities are insurance contracts that guarantee a flow of income for the life of a person or for a person and spouse. An annuity would give Henrietta a boost to her fixed-income returns, but the cost of that gain is high, Mr. Mastracci explains. She would be locking up money for her lifetime. She already receives a quarter of her income from indexed pensions. And because annuities are based on bond yields - very low at the present time - she would be buying at the wrong moment in the business cycle.
Henrietta could also boost her income by using a reverse mortgage that would convert some of the equity in her mortgage-free house to cash while putting her back into debt. Reverse mortgages are costly. The largest company in the field posts mortgage rates of 8.45 per cent to 9.7 per cent, depending on term. The standard reverse mortgage, which postpones payment of interest and repayment of principal until the house is sold, defers and compounds interest. Reverse mortgages are less onerous if property prices are rising fast enough to compensate for the interest cost. In the present market, however, home prices in Toronto are declining. Moreover, she already earns more than her target retirement income, he notes. She does not need to go back into debt.
Henrietta can raise her disposable income by reducing taxes on her taxable investments. The easiest move - shift $5,000 a year from existing capital, such as her $40,000 in cash, to a tax-free savings account in 2009. The TFSA will allow money on which income tax has been paid to grow without further tax and to be paid out without any restrictions.
Over a decade, she can invest $50,000. The tax savings, perhaps a few hundred dollars on each annual investment, along with her $2,502 present annual savings will enable her to pace inflation running at what Mr. Mastracci estimates will be 2.5 per cent a year.
She should move money from equity investments to bonds over the next decade as interest rates rise in an eventual economic recovery, aiming for an allocation of 70 per cent bonds, 30 per cent stocks by age 81, the planner suggests.
Government bond interest rates are very low right now, though they are likely to rise when the economy recovers. A ladder of Government of Canada bonds due in one, three and five years could be used.
She could also use bond funds with corporate issues, which are paying many times what government bonds now yield. But professional fund management is essential in a period when companies may cut bond payments, he says.
"Conservative investing has to remain the cornerstone," Mr. Mastracci says. "If she adds to her bonds over time and cuts her exposure to common stocks, she will have the income security she wants and sufficient inflation protection."
Client situation
THE PERSON
Retired woman in Toronto, age 71.
THE PROBLEM
Worry that crumbling stock values will impair her retirement.
THE PLAN
Raise bond allocations over time to increase income security.
THE PAYOFF
Less variation in retirement income.
NET MONTHLY INCOME
$3,000.
ASSETS
House, $700,000; taxable investments, $321,500; RRIF, $258,700; cash, $40,000. Total: $1,320,200.
MONTHLY EXPENSES
Property tax, $350; utilities, $270; phone and cable, $115; house insurance, $65; house maintenance, $200; medical and dental, $200; clothing, $150; food, $400; restaurant, $75; entertainment, $200; travel, $350; bus and subway, $84; charity and gifts, $170; miscellaneous, $200; savings, $171. Total: $3,000.
LIABILITIES
None.
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