“Portfolios” is an ongoing series that discusses various asset allocation options. In this issue, Investment Executive speaks with Karen Bleasby, senior vice president at Mackenzie Financial Corp. in Toronto; Daryl Diamond, principal at Diamond Retirement Planning Ltd. in Winnipeg; and Wolfgang Harder, senior client advisor at UBS Securities Canada Inc. in Vancouver.



A retired couple, both partners 65 years of age, each have $150,000 in RRSPs, $350,000 in non-registered assets and a pretax pension income of $30,000. They own a house in Toronto worth $1 million and a condominium in Florida worth $500,000, with no mortgage debt. They spend four to five months a year in Florida and live an active lifestyle. They have two grown children, one of whom they support from time to time.

They believe that annually they need $40,000 after taxes in today’s dollars for themselves, plus $20,000 to help one of their grown children with some household expenses; they want to have this income until they are 95. They would like to live comfortably and leave an estate of at least $1 million in financial assets, in addition to the real estate. They have bought blue-chip stocks in the past and they are relatively conservative investors.

With that much in pension income and assets, their goals are easily attainable. However, the three experts we interviewed think the couple may be underestimating the cost of maintaining their two residences and living their active lifestyle.

This is an important but not critical point. All agree that the couple will probably have a lot more than $1 million at age 95 if the partners stick to annual combined withdrawals of $60,000 in 2006 dollars — about $3 million in 2036 dollars, according to Harder’s projections; $4 million if all capital gains are deferred, according to Bleasby. (Which means they could withdraw another $20,000 a year and still leave at least $1 million.)

Harder also ran an additional scenario with combined withdrawals of $80,000 a year, which resulted in assets of around $1 million at age 95.

Diamond’s projections show similar results, but he points out that in order to ensure that these people have at least $1 million to leave their heirs, the better approach would be for them to take out a joint life insurance policy for that amount right now. This strategy would allow them to withdraw even more, says Diamond, who also advises the couple to take out a joint long-term health insurance policy to guard against medical expenses draining the assets. Such policies can provide up to $300 a day for health-care purposes.

All three advisors used conservative investment return assumptions — 6% after fees by Harder, 6.3% by Diamond and 6.8% by Bleasby. Harder and Bleasby are assuming 2.5% inflation; Diamond, 3%.

Harder did not include Canada Pension Plan and old-age security entitlements in his projections, so he needed to take more out of investment income or capital than Bleasby and Diamond. (Diamond estimates their CPP benefits at the maximum $10,128 a year each.)

Bleasby, who designs portfolio products for Mackenzie’s private client service, looks at all financial assets when making investment recommendations. In this case, she assigns a value of $1 million — $500,000 each — in fixed-income investments to the pension entitlements. This leads her to recommend 100% equity for the non-registered investment portfolio. With the RRSPs in fixed-income, the overall result is a financial asset mix of 35% equity and 65% fixed-income.

A major advantage of this strategy is that capital gains can be deferred indefinitely if the assets are invested in Mackenzie’s family of capital-class mutual funds. Her projections show that if the capital gains are deferred to age 95, the couple would have $4.1 million in 2036 dollars at that point; if the capital gains are paid each year, they would only have $1.4 million. For planning purposes, she suggests assuming they will have at least $2.5 million in 2036.

Harder, who is an investment advisor and a certified portfolio manager, wants to keep risk as low as possible and, as a result, looks for the minimum equity content that will allow the couple to meet their goals. For combined annual withdrawals of $60,000, they would need their equity content to be 26%; it would probably be higher if they should decide that they need more income.

@page_break@He also recommends allocating 15% of their assets to alternative investments, which lowers risk because these are only minimally, or not at all, correlated with equity and fixed-income while delivering an equity-like return. He suggests a UBS absolute-return fund that targets a 6% return (not including inflation).

Neither Bleasby nor Diamond include alternative investments in their portfolios. Bleasby says she would look at them when assets reached $1.5 million, starting with an initial allocation of 5% of the portfolio and never going higher than 10%.

Diamond, who is a specialist in financial planning for retirement, is focused on how to meet financial goals in the easiest and most tax-efficient way while generating income and preserving and modestly growing the assets. Besides life and long-term care insurance, he recommends depleting registered assets as quickly as tax efficiency allows.

This strategy is intended to minimize taxes upon the death of one of the partners, which would trigger a doubling of the required minimum RRSP or RRIF withdrawals and push the survivor into a higher tax bracket.

In this case, Diamond recommends that each person withdraw about $10,800 a year, with the exact amount to be calculated late in the year. This would bring each person’s annual taxable income close to the $72,000 threshold at which the third federal tax bracket kicks in; it would also exhaust their registered assets at around 80 years of age.

He also points out that, if they established testamentary trusts in their wills, they would lower the taxes paid by heirs on investment income during the heirs’ lifetimes.

All three advisors suggest discretionary managed accounts. Bleasby recommends investing all the money in Mackenzie capital-class mutual funds, for which the fee would be 1.45% of assets.

Diamond and Harder would both use a combination of managed money and individual securities. Harder would do the work himself for a 1% fee, while Diamond would recommend an independent investment counsellor — who would probably charge 1.5%-1.75% for the equity portion and 1% or so for the bonds.

Diamond suggests an asset mix of 63% equity and 37% fixed-income and cash, which is the opposite of Bleasby’s recommended asset allocation. Diamond’s emphasis is on income-generating stocks for the equity portion: 20% in income trusts, with most of the remaining equity portion in dividend-paying stocks.

Bleasby’s equity suggestions are tilted toward capital appreciation and have no specific income trust allocation, although fund managers might include them.

All three advisors would have some foreign equity because the resulting geographical and sectoral diversification usually results in less volatility and slightly higher returns than having all-Canadian equity. Bleasby would have 50% of the equity portion in foreign equity, split equally between U.S. and international stocks.

Diamond would have 61% of the equity in foreign investments; Harder, 79%. Diamond would have slightly more U.S. equity and Harder favours a little more international holdings.

To achieve an equity portfolio that is well diversified by geographical area, sector and style, Bleasby again recommends Mackenzie capital-class mutual funds.

Harder suggests UBS pools, exchange-traded funds and some individual stocks, with the proportion of the last rising as assets grow.

Diamond recommends mutual funds for the income trust portion and individual dividend-paying stocks for the rest of the equity.

Bleasby would use mutual funds for the fixed-income portion because she believes a well-diversified managed bond portfolio yields higher returns.

Diamond and Harder would create bond ladders, with Diamond recommending a strip-bond ladder, staggered annually and going out six to eight years initially. This would provide a compound return and lump sums to use for the annual RRIF withdrawals. Harder suggests a bond ladder going out two to six years.

None of the three are particularly worried about exchange rate movements negatively affecting the couple, despite the fact that they plan to live four to five months in the U.S. — although Harder would have about 25% of the assets in U.S. bonds. All three advisors say it is very difficult to be sure which way currencies will move.

They also note that currency movements tend to be neutral over the long haul, and that the odds currently suggest more declines in the U.S. dollar, which would benefit this couple when they change Canadian dollars into US$. IE