“Portfolios” is an ongoing series that discusses various asset-allocation options. This issue, Investment Executive speaks with David Duquette, vice president at HSBC Securities (Canada) Inc. in Calgary; Don Fraser, vice president at Connor Clark & Lunn Private Capital Ltd. in Toronto; and Lynne Triffon, vice president, and Scott Bruce, investment counsellor, at T.E. Financial Consultants Ltd. in Vancouver.



A couple, both partners 40 years of age, each have $250,000 in RRSP assets. They each earn $100,000 annually and, after maximizing their annual RRSP contributions, spend all of the remaining money. They have two children, aged three and five years, and they expect to pay for the children’s university education out of assets. Because the children are so young, the couple still have the time to set up RESPs. However, they need to know the most efficient way to do this.

The couple expect to retire at 65 and want to be able to count on a combined annual income of $150,000, or $98,000 after taxes (all figures are in today’s dollars unless otherwise specified), until they reach age 95. They have invested in stocks, bonds and options in the past. (The husband traded TSX Venture Exchange equities for fun before they bought their house five years ago.) Their house is worth $500,000, and they have a $300,000 mortgage. Neither one will get a pension.

According to Duquette’s and Triffon’s projections, the couple’s goals are not only reasonable, they are more than achievable. As a result, they say, the couple could set more ambitious goals.

Triffon’s scenario — which assumes an 8% average investment return after fees to age 65 and 7% thereafter — results in an estate of $3.5 million in 2061 dollars (or $925,000 in today’s dollars) if they spend the annual equivalent of today’s $98,000 after taxes. Alternatively, they could spend a net $110,800 a year and run out of money at 95. The two scenarios assume that RRSP contribution limits are not indexed to inflation, assumed to be 3% annually. But if they are indexed, and contributions are maximized, the estate would be larger.

Duquette, who assumes an 8.5% return, ran a scenario in which the couple made no more RRSP contributions because he believes they can achieve their goals with their current RRSP holdings. This would allow the couple to retire at 63 and still generate $98,000 after taxes. In this case, the couple would have very little left at age 95.

Fraser went with a more conservative 6% average return; that still results in a net $98,000 a year in today’s dollars, but with no money left at age 95.

Both Fraser and Triffon are against dispensing with RRSP contributions, saying clients should always defer taxes when possible. Fraser points out that for every $1 invested in an RRSP, the couple gets about 50¢ back through the tax deduction. But, he emphasizes, RRSP assets should be considered as worth about half of the equivalent in non-registered assets because taxes must be paid upon withdrawal.

Return assumptions are critical. Fraser goes with 6% because he wants to ensure the goals are achievable. He also recommends a balanced portfolio (60% in equities, of which 42% would be Canadian and 18% foreign, and 40% in fixed-income) because it minimizes the risk of high volatility, which can result in clients pulling out of investments at the wrong time.

Duquette, who would also use a balanced portfolio, recommends a weighting of 64% equities. He uses the historical returns for his asset mix, which includes 24% of the portfolio in global equities. Duquette says the couple could well qualify as aggressive investors but there’s no point in running additional risk when a balanced approach will meet their goals.

Triffon went with a growth portfolio (30% Canadian equities, 45% foreign equities and 25% fixed-income) because the couple appears to have a relatively high risk tolerance, as witnessed by the husband’s TSXV trading. Triffon did, however, pare back her return assumption to 8% from the 9.75% that her projections suggest the recommended asset mix would generate.

Triffon recommends putting 45% of the total portfolio in foreign stocks — the highest portion of the advisors. Triffon’s colleague, Bruce, argues for this approach because he believes foreign investments reduce market risk by ensuring that equities are broadly diversified geographically.

@page_break@Duquette and Fraser feel the couple don’t need that much foreign equity for good geographical diversification; as well, both advisors like the lower currency risk that comes with less global exposure.

Duquette, Fraser and Triffon all recommend the couple pay off their mortgage early. Triffon points out that mortgage payments are made with after-tax dollars. If assuming a 5.5% mortgage payment, it is equivalent to the money left after taxes from a 9.5% investment return — so they wouldn’t be losing by paying down the mortgage.

Duquette would also make sure the couple has enough life and disability insurance, given the young age of their children. He would then discuss their goals with them in detail, pointing out that they could afford to be more aggressive, especially in the next 10 years or so, and he would ask if they want to leave a legacy or retire earlier.

All three advisors would have annual discussions about the clients’ financial situation and goals.

In terms of the children’s education, Triffon recommends RESP investments of $4,000 a year for five years for the oldest child and for three years for the younger one, to catch up on missed grant room from previous years. Thereafter, she recommends an annual investment of $2,000 per child. Assuming a 7% return, this results in $15,000 a child a year for four years of university. She says recent figures suggest $10,000-$18,000 for annual expenses for a child going to university out of province. She says the couple could invest more aggressively for the first seven to10 years, which would probably generate more income.

Duquette suggests putting in just $2,000 a year per child and Fraser recommends only $1,000 a year per child. In Fraser’s case, the RESP generates almost $5,000 a year per child for four years, while Duquette’s projections result in $6,000 a year for four years for each child.

All three advisors recommend accessing institutional money managers through wraps or pools. They believe that’s the best way to minimize downside risk, find less risky but good investment opportunities (particularly globally) and get proper sector and style diversification. They also like the monitoring of mandates and investment performance that comes with wraps or pools.

Duquette would use wraps for the RRSPs and mutual funds for the RESP. He thinks wraps will provide a disciplined approach to the couple’s investing, making it difficult for them to deviate from their philosophy and asset allocation, and ensuring they don’t look to the TSXV or options to enhance returns.

Fraser and Triffon, on the other hand, would use pooled funds for both. Bruce points out that a managed solution is particularly good for a situation in which both husband and wife are working and raising a young family.

CC&L can either customize a portfolio or implement a clients’ mandate using one of six portfolio models, each of which has versions that include alternative investments. Fraser generally recommends the six portfolios because these represent the company’s best investment strategies and ideas. In this situation, he says, the balanced pool that includes alternative strategies is the best option.

Both HSBC and T.E. Financial offer more customized solutions. At HSBC, there are 50 mandates and 14 managers that can be used in the Diamond pool program Duquette recommends. At T.E., advisors not only can use in-house pools, they can also access any others by negotiating directly with managers.

Duquette would defer discussion of alternative strategies until assets reach $1 million, while Bruce is not entirely convinced that they should be used in “average” portfolios. This is partly a matter of availability for clients with less than $1 million, he says, but also because of issues concerning reporting and transparency.

Fees are lowest at CC&L at 1.25%, vs 1.76% at T.E. Financial and 1.5%-2.25% at HSBC. IE