Client’s life phase sets the course

“The difference between the two phases is the difference between saving and spending money,” says Kevin Chong, financial advisor with RGI Financial Services Inc. in Markham, Ont. “You can save and invest using a variety of strategies to accumulate wealth. During the disbursement phase, you can only spend how much you accumulate. You must avoid running out of money, based on assumed life expectancy.”

Typically, during the accumulation phase, the focus is on growth of assets, says Sanjiv Sawh, executive vice president of Investment House of Canada Inc. in Toronto. “The construction of the portfolio will depend on how much money the client wishes to accumulate over a specified period, which will, in turn, determine how much should be invested and the rate of return required for achieving the desired goal.”

The expected rate of return is based on the asset mix selected, which is determined by the client’s risk profile.

“It is important to note that in the accumulation phase, the asset mix must be tailored to reduce taxes when investing in registered plans vs non-registered plans,” Chong warns. “The non-registered plan should hold assets that generate capital gains and dividends, which benefit from preferential tax treatment, while interest-bearing assets should be held in the registered plan.”

Dollar-cost averaging

Given that growth is normally the main objective during the accumulation phase, it is prudent to take advantage of dollar-cost averaging when making regular contributions. This strategy allows the client to buy units of a security at different prices, with the objective of achieving an average cost that is lower than the current market price over time. It works best with growth investments, which tend to be more volatile.

“We encourage clients in the accumulation phase to make regular contributions to their portfolio. This strategy can reduce the financial stress associated with making a large lump-sum contribution,” says Jordan Zinberg, investment advisor with RBC Dominion Securities Inc. in Toronto. “In our experience, the use of mutual funds is the most effective way to deal with the monthly inflows. It allows us to put the client’s money to work as soon as it comes in each month.”

It can be more difficult to use monthly contributions effectively in portfolios that hold individual stocks and bonds, Zinberg adds, because monthly contributions must be accumulated until enough funds are available to establish a new position, which can reduce the positive effects of dollar-cost averaging.

While growth of assets is the major objective during the accumulation phase, sustainability of income is the major concern during the disbursement phase. Whether the accumulated wealth will be sufficient to last the client throughout his or her retirement years becomes the central question.

“Constructing a portfolio in the disbursement phase is often challenging [because] a certain portfolio value must be maintained while making the required withdrawals,” Sawh says. “One can gauge the distributions of some investments — for example, mutual funds, which have targeted distributions, or bonds, which have defined coupon payments.” However, Sawh adds, when the required cash flow adjusted for inflation is greater than the anticipated distributions, additional risk must be taken to achieve the desired income. That risk could decrease the value of the portfolio in unfavourable market conditions.

Rate of return

“The toughest task is to achieve the required rate of return without depleting the relative value of the portfolio faster than it is growing,” Chong says. Although the asset mix generally favours income generation as the client gets closer to the disbursement phase, changes in market conditions can disrupt income expectations. Plus, some clients may still need to hold significant growth assets during their retirement years in order to make up for shortfalls that occurred during the accumulation period.

“When dealing with a client in the disbursement phase, an assessment has to be made to determine how much money they will need, at what frequency and for what projected period,” Sawh says. “The choice of investments would typically provide a level of distribution and have low volatility, such as fixed-income securities and dividend-paying equities.”

@page_break@For non-registered portfolios, the distributions of the investments are matched to the amount of withdrawals, requiring an assessment of projected distributions from income-producing securities.

If the client has a registered portfolio, minimum withdrawals must be made, based on income, which increase as the client ages according to income tax rules. “There is less emphasis on analysing the distributions of the investments, with a focus on the order of redeeming the investments,” says Sawh.

Typically, assets are redeemed with the aim of reducing taxes.

Zinberg says that a simple strategy would involve setting aside enough cash equivalents to fund the disbursement requirements in the short term. For larger portfolios, the income and dividends generated by the portfolio can often cover the monthly cash requirements. He also suggests holding funds that pay annual returns classified as “return of capital,” which can meet monthly cash requirements in a tax-efficient way. Alternatively, the portfolio could hold GICs, preferred shares and income trusts to increase the overall yield.

“The objective during the disbursement phase is to ensure that clients do not outlive their money, while receiving a tax-efficient stream of income.” Chong says. IE