“Portfolios” is an ongoing series that discusses various asset-allocation options. This issue, Investment Executive speaks with Don Fraser, vice president at Connor Clark & Lunn Private Capital Ltd. in Toronto and Todd Kennedy, investment advisor at HSBC Securities (Canada) Inc. in Ottawa.



A couple, both partners 50 years old, each have RRSP assets of $125,000, non-registered assets of $125,000 and incomes of $100,000. They have two university-aged children — one of whom will graduate in two years and the other in four years — whose educations cost $8,000-$10,000 a year per child.

The couple also have a house and a cottage, each worth $500,000, with $200,000 in total mortgage debt. They have small pensions from previous employers, which are fully indexed to inflation, that should pay them a combined $50,000 per year pre-tax in today’s dollars during retirement, which will start when they turn 65.

The couple lead an expensive lifestyle and they expect that they will require $100,000 in annual pre-tax income, or $75,000 after taxes in today’s dollars, from their pension income, the Canada Pension Plan, old-age security benefits and investment income to meet their needs during retirement until age 95. This would include the money necessary to spend four months of every year in the southern U.S.

In terms of their investments, the couple have invested in stocks and bonds in the past and have a modest risk tolerance.

Both Fraser and Kennedy say the couple can reach their income goals, although Fraser is surprised that the couple believe they can maintain two residences and pay the annual expense of living in the U.S. for four months each year on $75,000 in 2006 dollars (all figures in this story are in today’s dollars, unless otherwise specified).

As a result, Fraser ran two scenarios to see how much the couple could afford to spend after taxes without running out of money before they are 95. These are based on investment returns of 6% a year after fees, annual inflation of 3% and a reduction in their pensions equal to the CPP entitlements, which is often the case with fully indexed pensions.

The first scenario shows that they could continue to live on $100,000 — which is what he calculates they would have remaining after taxes, mortgage payments and RRSP contributions — until 65 and then spend $90,000 a year to age 95.

The second has them dropping their discretionary spending to $94,000 per year immediately and maintaining that until they reach 95.

In both cases, they would have nothing left at 95 instead of the $2.2 million in 2051 dollars he projects they would have if they spend only $75,000 a year during retirement.

Kennedy took the couple at their word in terms of what they will need to live on; although he says that if they find they need $90,000 after taxes, it could probably be generated. He has assumed a much higher 9% annual return until retirement and around 7% annual return thereafter, with annual inflation of 3.1%, no reduction in pensions and no RRSP contributions. If they can manage on $75,000, his projections suggest they would have about $1.5 million in assets when they’re 65 in 2021 dollars and $3 million in 2051 dollars, when they’re 95 years old.

Kennedy bases his assumptions on the 50-year historical average for equities, fixed-income and inflation, while Fraser goes with a very conservative estimate on investment returns to minimize the possibility that these goals are not achieved.

If the couple decide that they will, indeed, need more than $75,000 per year during retirement and, in turn, start putting money aside to achieve this, Kennedy suggests they put the assets into the non-registered account and not into the RRSPs.

“There’s not a lot of flexibility when taking money out of a RRSP from a tax point of view. You can be more creative outside, given the dividend tax credit and tax levels on capital gains, and you don’t have to pay big taxes if you need a lot of money in one year for, say, a large trip, a new car or to give to the kids,” he says, adding that tax treatment is more and more in favour of financial investments and he expects that to continue. Furthermore, the fees for non-registered assets are tax-deductible if paid directly by the investor, while the fees paid in an RRSP are not tax-deductible.

@page_break@Neither Kennedy nor Fraser thinks the couple should be in any big rush to pay off the mortgage; they should just make sure it’s done by the time they reach 65, though. However, Fraser does suggest paying off the mortgage and changing the debt into an investment loan or a line of credit. That’s because interest on a principal mortgage is not tax-deductible, whereas interest on loans used to generate investment income is tax-deductible.

In terms of account structure, both advisors would recommend a discretionary managed account. Kennedy says this couple looks like they would be a little more “hands off” than most investors, which would make discretionary management attractive to them. But he would discuss moving them to individual securities when they reach $1 million in assets.

Fees would be 1.25% of assets in Fraser’s case, with the money invested in pooled funds.

Kennedy would charge 2.5%, but says this can be negotiated as assets grow. He would recommend investing in wrap accounts, which he particularly likes in terms of managing the foreign content.

Fraser notes that many financial advisors can access CC&L’s investment-management services for their clients under CC&L’s Mainstreet program if the advisors’ firms have signed up, which many have already done. Advisors can then add a fee for general financial, tax and estate advice, which might bring the total fee to 2%. Launched two and a half years ago, Mainstreet is the fastest-growing segment of CC&L’s private client business, with $200 million of its $1.3 billion in assets in the private client operation. Pools are typically used with assets under $1 million.

As for asset allocation, Kennedy suggests placing the couple’s investments 100% in equities; Fraser recommends a “balanced” 60% equities/40% fixed-income weighting.

Kennedy says the couple don’t need cash and already have $1 million in real estate. And with fixed-income returns at “super-low rates,” he suggests they build up their portfolio with growth investments.

Both Kennedy and Fraser would put 30% of the equities into foreign companies. But with equities only 60% of Fraser’s asset mix, that works out to just 18% of the total portfolio. With the U.S. dollar likely to remain weak, Kennedy says, it’s a good time to build up the Canadian side.

For the foreign equities allocation, both advisors would place half of the assets into U.S. equities and half into a combination of Europe, Asia and the Far East (EAFE). There would be no emerging markets exposure. Fraser would have some small-cap exposure but Kennedy wouldn’t.

Kennedy’s wrap account would take care of style, as it would have a blend of growth and value and be well diversified by sector. Income trusts would also be included. He would not recommend alternative investments at this point, but would look at them when the assets reached $1 million.

For this couple, Fraser recommends a balanced mandate that includes alternative investments.

There would be currency hedging, as well as the use of other derivatives. The alternatives are invested in a fund of hedge funds, with diversification by both strategies and managers.

Fraser says the use of alternative investments lowers risk and volatility because they offset stocks and bonds when those assets are weak. “The more risk-averse the client, the more attractive hedge funds become because they provide a source of diversification and lower the volatility of the return,” Fraser notes.

CC&L uses a core, or neutral, style for the foreign equities. Fraser says it’s a bottom-up approach that’s driven by fundamentals and is tightly constrained. A minimum of 20 and a maximum of 30 companies are held in each of the U.S. and EAFE pools, and no one stock can account for more than 9% of the pool nor appreciate more than 10%; cash held ranges between zero and 25%. The target return is three percentage points above the four-year rolling return for the EAFE and S&P 500 indices.

The Canadian equities are divided into large-cap value, large-cap growth at a reasonable price, small-caps, an income fund and a fund of hedge funds. The fixed-income portion is actively managed, with 5% in international holdings. Currently, the fixed-income is being run with a “barbell strategy,” with one-third having durations of one year or less because of the rising interest rate environment.

Fraser says that CC&L doesn’t typically change asset mix at retirement.

Kennedy doesn’t know what, if any, changes he’d suggest for the couple when they reach 65. He would have to see what level interest rates are at; how tax rates have changed; and what new investment vehicles are available. However, with his assumption of a 7% return after retirement vs 9% before, the portfolio would probably become more conservative and contain some fixed-income.

Reviews of portfolios do not, of course, wait for retirement. So, both Fraser and Kennedy would continually review the portfolio and the clients’ needs. IE


Retirement projections are necessary for financial planning but are inherently uncertain. Because of changing market, taxation and personal conditions, assumptions and projections must be continually reviewed and updated.