“Portfolios” is an ongoing series that discusses various asset-allocation options. This month, Investment Executive speaks to Karen Bleasby, senior vice president, and Sandy Carty, vice president, tax and estate planning, at Mackenzie Financial Corp. in Toronto; Todd Kennedy, investment advisor at HSBC Securities (Canada) Inc. in Ottawa; and Lynne Triffon and Scott Bruce, both vice presidents at T.E. Financial Consultants Ltd. in Vancouver.



A couple, with both partners 40 years of age, has two young children and a $200,000 mortgage on a $600,000 home. The husband is an entrepreneur who makes $150,000 a year; the wife is a lawyer by training who has worked part-time since the first child was born 10 years ago. She earns $50,000 a year, but expects to go back to full-time work in another four years, when both children are in high school. That would boost her annual income to $150,000. Both expect to work until age 60 and don’t have pension plans, although he has $150,000 in his RRSP and she has $50,000 in hers.

Both have relatively high tolerance for risk, provided that the securities purchased are not speculative. Their goals are to pay for a university education for both of their children — for which they will need about $100,000 in real terms — and have income at retirement equal to 70% of pre-retirement after-tax income, which is assumed to increase at the rate of inflation between now and retirement. Their retirement income will need to rise with inflation, as well.

Can they meet their goals without additional savings after they maximize their RRSP and RESP contributions? The answer is probably “no.”

Triffon, a registered financial planner, says it would take more than an 11% average annual return after fees to accomplish that, and all agree that is unrealistic.

Kennedy thinks a 10% return is reasonable, given that the average dividend fund had an average annual compound return of more than 12% for the past 10 years. In that case, the couple would still need to save $20,000 a year in today’s dollars to hit their target. Kennedy, who is assuming 3.1% annual inflation, says once they retire and adjust their asset allocation, they could only expect their portfolio to generate an 8% annual return.

Bleasby believes 7%-7.5% is more realistic, which translates into a 4.5%-5% real return, given an an assumption of 2.5% annual inflation. Triffon would go with 8% after fees, but she’s assuming 3% inflation, which means a real return of 5%, the same as the top of Bleasby’s range. Both Bleasby and Triffon would target a retirement return one percentage point lower.

Kennedy is assuming a life expectancy of 84 years for the husband and 88 for the wife. He says that, at that point, there would still be assets “in the mid-six-figure range” left (he would expect income requirements to drop by a third after the first death). Bleasby and Triffon assume life expectancies of 90 for both.

Because Triffon is planning for lower investment returns, she says the couple would have to save an extra $53,000 a year to meet its goals. If they don’t want to save that much, they would need to halve their expected after-tax retirement income to $70,000 from $140,000. They may go for that, especially considering that meeting the original goal means their portfolio would be generating a monthly return of $11,700 after they retire.

They could also go for something in between, saving some, but not $53,000. It all depends on how much discretionary income they want now or how much they want in retirement. For example, do they want to travel extensively once they stop working or do they want to travel now with the kids? Triffon notes the extra savings wouldn’t need to be as high if the RRSP contribution ceiling is indexed to inflation after 2010, something not assumed.

Bleasby looked at the age at which the couple could retire without any additional savings and still meet their income goal. Given her return assumptions, that age would be 65. If returns turn out to be lower, the two would need to work longer and/or reduce their income expectations.

All the advisors agree that maximizing RRSP and RESP contributions is the first priority and assume this will be done. (The couple can contribute up to $4,000 a child a year in an RESP, to a maximum of $42,000.) The advisors also recommend that the husband make spousal contributions as soon as possible to even out the RRSPs, which would put them in the most efficient tax situation in retirement.

@page_break@Triffon says one RESP is better than two because that would provide flexibility if one child’s education proves to be more expensive than the other’s. Bleasby points out that the couple wouldn’t get the full grants under the RESP program unless it is set up by the time a child is aged nine.

However, Carty suggests the couple consider putting aside additional money for the children’s education. She calculates the cost of post-secondary education could be $200,000 for both children in today’s dollars. “Most children leave home to attend university,” she says.

She suggests using an “in trust” account and putting the money into equity funds, such as global growth funds, that don’t generate much income. In an “in trust” account, taxes aren’t paid on capital gains until gains are realized, whereas taxes on interest and dividends would have to be paid. When the income does come out of this account in the form of capital gains, it would be attributed to the child, so little, if any, income taxes are paid.

Bleasby and Triffon say the next priority would be to pay off the mortgage, which would presumably be easier once the wife is back at work full-time.

Kennedy thinks the additional savings should be the priority — as long as the mortgage is paid off by retirement. Assuming the couple accumulates enough non-registered assets, they should consider paying off the mortgage and re-borrowing for investments, as the interest on the latter is tax-deductible, he adds.

If the couple hasn’t managed to build up non-registered assets by the time they are 55, they should reconsider maximizing their RRSPs, says Kennedy. He says it’s best to retire with a combination of registered and non-registered assets, so if they need an unusual amount of money one year — for, say, a major purchase or to give to a family member — it can be taken out of the non-registered assets without paying a lot of taxes.

Despite different strategies, the advisors recommend similar asset mixes. Kennedy and Bleasby would weight the portfolio 80% equities and 20% fixed-income, whereas Triffon would weight it 75% equities and 25% fixed-income (of the latter, 5% in global instruments).

As for geographical distribution, Bleasby would split the 80% equity weighting into 35% Canadian and 45% foreign (25% U.S. and 20% international); Triffon would distribute her 75% equity weighting 30% in Canada and 45% foreign (20% U.S., 20% international and 5% emerging markets); and Kennedy would divide his suggested 80% equity weighting into 50% Canadian and 30% foreign.

Bleasby and Triffon both want the lower market risk that comes with going global. Kennedy, on the other hand, says: “Canada is a good place to be. My experience is that there are very good ideas in Canada that we have been able to capitalize on. In addition, you remove currency risk.”

In terms of products, Bleasby — who designs and manages various Mackenzie asset allocation programs — would use Mackenzie’s Keystone, which consists of mutual funds and capital trusts. It is “very much geared to RRSP investments,” she says. The program is structured as a fund of funds, with individual funds in each portfolio that provide geographical, sectoral and style diversification, as well as small-cap investments in all core geographical areas. Keystone also automatically rebalances, with an MER around 2.8%. She also suggests the couple could use Mackenzie’s Symmetry asset-allocation program, which allows for further customization of fund selection.

Once the couple’s assets reach $500,000, they may want to consider Mackenzie Private Client Group’s Portfolio Architecture Service, says Bleasby. This allows for customization of fund allocation, and has lower fees and access to Mackenzie’s tax- and estate-planning services.

Bruce would use the company’s Prosperity pooled funds “to have access to top-quality institutional managers.” Like Mackenzie’s Keystone, pools provide for geographical, sectoral and style diversification, as well as small-cap exposure. However, rebalancing is not automatic, so the advisor would have to do it. At T.E., they not only rebalance monthly within 5% of the target, but also bring the portfolio back to neutral once a year.

Annual fees for T.E.’s pooled funds start at about 2% and decline as assets increase. Other options are available once assets reach $1 million, but Bruce wouldn’t necessarily recommend a change. “Pools are fine with $5 million,” he says.

Kennedy would start by using wrap accounts. When the assets reach $350,000, he’d buy individual securities for the Canadian portion but maintain the wraps for the foreign. At that point, he’d move the couple into a flat-fee account, with an annual fee of about 2% of total assets. That would imply a break for the fee on the wraps, which are normally 2.75%. Fees would decline further as assets rise, dropping to about 1% at $1 million.

Sectoral diversification is not a priority for Kennedy. “Wraps aren’t designed for sector rotation,” he says. For foreign equity wraps, he looks for geographical and style diversification. For the Canadian portion, he is “comfortable with about 20% of the total portfolio in one sector.” Thus, 40% of Canadian equities portion could be in energy. Financial services could be just as high, but he wouldn’t go any higher than 15% for income trusts for now — although he might go as high as 25% when the couple retires in order to generate more income. He would also keep the weightings for sectors such as technology or biotech low.

Kennedy says exchange-traded funds can be used for the foreign equity, but not initially. Because the couple would have to buy Barclays Global Investors Canada Ltd. ’s U.S. iShares in lots of 100, this would mean an investment of US$5,300- US$10,500 a trade. On bigger accounts, he’d consider iShares for their geographical and sectoral reach at a low cost. He notes that Barclays has also just come out with an iUnit for the S&P 500 composite index that is fully hedged into Canadian dollars, and he might consider this.

Kennedy would ladder the investments in the fixed-income portion of the portfolio. He wouldn’t go out more than five years, but that could change by the time the couple’s assets reach $350,000.

Kennedy would probably consider alternative investments once the assets reach $600,000, but for no more than 5% of the portfolio; Bleasby would look at them for 5%-10% of the portfolio once assets are more than $1 million; and Bruce would wait until the portfolio hit the $2-million mark before moving up to 5% of the portfolio into this asset class. In the meantime,he would stick with the less risky multi-manager, multi-style pools.

All three say they’d alter the asset mix as the couple neared retirement to reduce volatility and increase cash flow. Bruce suggests 60% equities upon retirement; Bleasby prefers 55%-60%, although she qualifies that it would depend on the couple’s objectives and risk tolerance at the time; Kennedy would review the portfolio closer to retirement. IE