“Portfolios” is an ongoing series that discusses various asset-allocation options. This issue, Investment Executive speaks with Karen Bleasby, senior vice president at Mackenzie Financial Corp. in Toronto; David Duquette, investment advisor at HSBC Securities (Canada) Inc. in Calgary; and Don Fraser, vice president, Toronto, and Jeff Guise, portfolio strategist, Vancouver, at Connor Clark & Lunn Private Capital Ltd.



A couple, with both partners 50 years of age, have a small mortgage on a $400,000 house and $200,000 in taxable financial assets. They are currently paying for their two children’s university education — one will be finished in two years and the other in three years. The husband makes $100,000 a year and wants to continue working until he’s 65. The wife earns $50,000 annually; she would like to retire in five years and collect early retirement. Both have pensions indexed to inflation that will provide 60% of their pre-tax income.

Their goal is to have retirement income that is 100% of today’s income, in real terms, to age 90. During retirement, they plan to travel extensively and indulge their passion for golf; they want to join a golf club in their community. They are prepared to save to fill the gap, but need to know how much they should put away.

Bleasby and Fraser say the couple could probably meet these goals, but they’d have to save vigilantly. Duquette, on the other hand, doesn’t think it can be done.

As Bleasby sees it, the couple would need an average annual return on their investments of more than 11% after fees in order to accomplish their goals. None of the advisors thinks this is realistic. Rather, Bleasby believes that an 8% return, or a 5.5% real return after adjusting for inflation of 2.5%, is a reasonable expectation. Duquette’s scenario has a 7%-8% return, or a 4%-5% real return — he is assuming a more conservative 3% inflation — and Fraser is assuming a 6% nominal return and a 3.5% real return.

Given an 8% return, Bleasby says, the couple would need to save 5% of their gross income, or $7,500 (all figures are in today’s dollars, unless specified otherwise) to generate the equivalent of $150,000 today to age 90. However, she warns, if the couple earns a lower rate of return, the two would have to make choices: the wife could work longer, they could save more or they could reduce their retirement income goals.

With Fraser’s assumption of a lower 6% return, he calculates that the wife would need to save $4,000 a year for the next five years and the husband would need to save $9,000 annually until he’s 65. Or, Fraser says, the couple could accept retirement income of $89,000 a year, after taxes, using their current holdings. That’s $16,000 a year less than the $105,000 he calculates they net from $150,000 annual income based on Ontario’s current tax rates. It is also what he would recommend.

As for Duquette, he says the couple would need to save $1,750 annually, even if the wife works to 65 — which is what he recommends. The continued savings and the wife’s extended working life is due, in part, to his assumption of 3% inflation, which increases the nominal income required to meet the retirement income target.

In addition, Duquette doesn’t think the couple should let their assets run down to zero, which occurs at age 90 in Fraser’s scenario. In Duquette’s plan, the two would still have financial assets of almost $900,000 in 2046 dollars, when they would reach age 90. (Note: Duquette is using Alberta tax rates and derives the higher after-tax income of $112,000 from their current income of $150,000.)

Bleasby and Duquette agree that the couple should reconsider how much they will need when they both stop working. Duquette says the rule of thumb is that income requirements usually shrink to 70%-75% of pre-tax income in retirement. (Fraser’s $89,000 after-tax suggestion works out to 85%.)

The difference in return assumptions lies only partly in the asset mix the three recommend. Bleasby would weight the portfolio 100% in equities, whereas Fraser would aim for 50%-60%. Duquette’s equity weighting is similar to Fraser’s, sitting at 55%-60%, but he expects a greater rate of return.

Bleasby’s 100% equity recommendation is based on the fact that most of the couple’s financial assets — $730,000 by her calculations — is in their pensions. And because she considers this to be essentially a fixed-income portfolio, their overall equity exposure would be just 21.5%.

@page_break@Fraser recommends starting with a balanced mandate, which can range between 50%-60% equities, depending on the economic environment and financial markets, and then looking for reasons to divert from that. This depends on factors such as risk aversion, time horizon, experience in capital markets, income requirements and retirement plans. In this particular case, he sees no obvious reason to vary from that asset mix.

Duquette thinks 55%-60% in equities is appropriate, but would spend time with the couple to determine their risk tolerance, including quantifying the downside risk of various asset mixes.

Both Fraser and Duquette recommend setting up and maximizing RRSP contributions. Fraser has assumed that after the pension adjustment, the two would qualify for a RRSP contribution of 50% of 18% of gross income. That would be $9,000 for him and $4,000 for her in the first five years, which means all their savings would go into RRSPs. With his assumption of a 6% return, RRSP assets would reach $339,000 in 2021 dollars when the husband retires at 65; the non-registered assets would total $471,000. Their money would last until they reach 90 years of age.

As for Duquette, he’s going with a more conservative allowable RRSP contribution of 25% of the 18% of gross income. He is also assuming that they contribute their full carry-forward of unused RRSP room, which he calculates at a conservative $75,000. He says that in addition to the annual $1,750 RRSP contribution, contributions should be made in kind from their investment account.

However, he says, this should be done in the most tax-efficient way. The couple should make sure additional contributions don’t push them too far into a lower tax bracket, ensuring that they receive the maximum benefit of tax savings through their RRSP contributions.

As well, Duquette adds, all RRSP contributions should be made to a spousal RRSP in the wife’s name; even with combined pension and RRSP income, her retirement income will be lower than her husband’s. Assuming the couple earn a 7% return in the RRSP, 8% for the non-registered assets and both retire at 65, they would have $351,000 in 2021 dollars in the RRSP and $205,000 in taxable assets; their house, assuming an average annual increase in value of 2%, would be worth $538,000.

Bleasby makes no assumption about possible RRSP room, so the 5% of gross income that she recommends they save each year to retirement after the children have finished school remains taxable. In her scenario, assets would reach $870,000 in 2021 dollars.

Bleasby, who designs and manages asset-allocation programs, recommends Mackenzie’s Symmetry program, which defers capital gains when portfolios are rebalanced. The annual fee is 2.8%.

Duquette would start with a simple fee-based transaction account invested in F-class mutual funds and exchange-traded funds. When assets reach $300,000, he would add individual securities. When the couple retire at 65, given their desire to travel, Duquette suggests they move all the assets, which would be about $500,000, to a managed wrap account, in which the couple wouldn’t need to be consulted on trades. In this instance, he would use HSBC’S Diamond portfolio. Fees would be 1.5%-2.25%.

As for Fraser and Guise, they suggest a fee-based account invested in pooled funds. (They wouldn’t recommend buying individual securities for an account holding less than $1 million in assets.) Although this account is too small for CCL — it usually doesn’t take accounts less than $800,000 — they note that pooled funds are widely available. In addition, they say, it’s reasonable to pay 1.5%-2% fees on such accounts.

All of the advisors recommend foreign equities to provide broad geographical and sector diversification. This would lower downside risk and reduce volatility. Bleasby recommends a 30% weighting in Canadian equities and a 35% weighting both in U.S. and international equities. Duquette would have half the equities in Canadian and the rest in global equities, diversified according to the MSCI global weightings. Of Fraser’s 50% equities weighting, 30% would be placed in Canadian equities and 20% in foreign equities.

As for sector and style diversification, Mackenzie’s Symmetry and most pooled funds accomplish that. Style diversification, Guise says, is important to lower short-term risk.

Duquette would use ETFs to get sector diversification and mutual funds for a mix of styles and exposure to both Canadian and foreign small-caps. He says that both style and exposure to small-caps can add significantly to return. He cites a study that shows the Standard & Poor’s 500 total return index from 1967 to 1997 had an average annual compound return of 11.9%. Small-cap exposure increased that return to 14.5% and, if the small-caps were managed with a value style, the return increased to 18.5%.

In the case of Canadian equities, Duquette would buy an income fund, which would include income trusts. When total assets reached $300,000, he would add blue-chip dividend-paying Canadian stocks in different sectors to be held for the long term. He would, also, keep the ETFs and mutual funds. On the foreign side, he would stick with ETFs and mutual funds.

In terms of the fixed-income portion, Fraser would use pools. “We believe in active management. Opening up the fixed-income holdings to corporate bonds, both investment-grade and lower, provides for opportunities that can add value,” says Fraser. Duquette would ladder the fixed-income over five years.

As for alternative investments, Bleasby says “no” for anyone holding less than $1 million in assets, whereas Duquette would consider allocating 10% of the portfolio to such investments when assets reach $500,000. IE