Divorced engineer's goal is to grow his portfolio to $3M in next five years
In Ontario, a computer engineer we'll call Harry, 45, is raising his five-year-old daughter, Lydia. His pre-tax income is $16,600 per month. He has $680,788 of various financial assets and a $250,000 outstanding mortgage with a 2.6 per cent interest rate. It seems a tidy financial picture, but Harry worries that the costs of raising Lydia and paying down his mortgage will make it hard to retire at 65. Moreover, he wants to expand his financial assets almost five-fold to $3 million in the next five years. His ultimate retirement goal is to leave Canada for someplace warmer with a $3-million capital gain.
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Harry.
“Harry is his own and only financial resource,” Einarson explains. “He is unsure if he should use his $274,900 cash to pay down his mortgage on an accelerated basis or invest in stocks and bonds. Finally, he considers that when retired, he might move abroad where some costs are lower than those in Canada.”
EDUCATION AND RETIREMENT
The first priority is Lydia's education. Her RESP has a balance of $19,578 and Harry contributes $500 per month to the plan, far in excess of the $208 needed to maximize the Canada Education Savings Grant of the lesser of 20 per cent of contributions or $500. Moreover, the CESG has limit of $7,200 per beneficiary to age 18 and $50,000 total contributions per beneficiary. He can reduce contributions to $2,500 per year for the next 13 years to Lydia's age 17. That's $3,000 per year in total. If he does that, then the present balance of the account will grow to $77,000 assuming a three per cent annual return after inflation by the time she is ready for post-secondary education at age 18. That would pay for tuition and books at any university in Ontario provided that Lydia lives at home.
The long-term question is how Harry can retire. Making choices of where and how to save and invest is complex.
Harry's $10,900 in monthly allocations include $1,000 for his mortgage, $900 to an ex-spouse, $500 to the RESP and $500 per month to his TFSA. He banks any surpluses. His personal cost of living without savings and transfers to his ex-wife are only about $1,700 per month for basics. He'd like to be able to spend $6,000 per month during a 30-year retirement.
At present, Harry has $283,710 non-registered stocks and mutual funds, $72,600 in his RRSP, $30,000 in his TFSA.
Harry's mortgage has a 2.6 per cent interest rate, which is less than the recently reported 3.7 per cent Canadian inflation rate. Some of what he puts into the mortgage comes back as return of capital. Given the low real rate of interest and the flowback of some of his payments, there is no rush to pay off the debt. Let it ride, the planner advises.
Harry hopes he can transfer his $250 monthly excess RESP contribution to his mortgage. That would cut his amortization by about five years, depending, of course, on interest rates when his present note rolls over as his five-year terms are renewed.
Harry has about 42 per cent of his financial assets, including the RESP, in cash. The balance is in diversified mutual funds and large-cap stocks.
RETIREMENT MATH
For now, Harry's $72,600 RRSP growing with no further contributions for the 20 years to age 65 will rise to a value of $131,150 assuming a three per cent annual return after three per cent inflation. That money could generate $6,500 annuitized annual income, including return of principal, for the 30 years from Harry's age 65 to his age 95.
His non-registered funds and cash with a present value of $558,610 growing at three per cent for 20 years can rise to a value of $1,008,940 and then pay out an annuitized $49,975 for 30 years to his age 95 with the same assumptions.
His TFSA with a present balance of $30,000 growing with $6,000 annual contributions will rise to $220,240 in 20 years and then contribute $10,900 per year to his income for the following 30 years. He will be able to draw full Old Age Security at a 2021 rate of $7,518 per year subject to clawback and an estimated $14,400 of Canada Pension Plan benefits.
Harry's total income at 65 would then be $6,500 from his RRSPS. $49,975 from non-registered funds and $10,900 from his TFSA, total $67,375 plus $21,918 combined from CPP and OAS for a total of $89,393. After 20 per cent tax on all components excluding TFSA and return of TFSA cash flow to the calculation, Harry would have $73,614 per year to spend.
CAPITAL GAINS GOAL
Harry's goal to grow his portfolio to $3 million in five years would require that he take immense risks on hot stocks or make high interest but risky loans to private businesses or individuals. He would court disaster.
To attain that $3 million, Harry would have to save $85,000 per year for five years on top of present savings other than the RESP and attain a 27 per cent annual rate of return after tax. That is an unrealistic rate of growth. It might be possible with exceptional luck picking growth stocks, but the reality is that even very experienced investors do not sustain these results. More reasonable gains are possible, however.
If and when Harry leaves Canada for a foreign country, he can sell his house and keep an assumed 95 per cent of the $800,000 present price. $760,000 after primping and commissions earnings three per cent after inflation would add $22,800 per year to income without eating into his capital. That would make his topline income rise to about $112,200 before tax.
Tax would depend on future fiscal policies in whatever country Harry chooses. He can continue to receive his Old Age Security and Canada Pension Plan benefits, RRSP/RRIF payouts and residual income from his company subject to withholding rules for each income flow. But $3 million based on current income and savings is for a casino, not a reasonable financial plan.