PORTFOLIO ADVISOR

Bob Dreumon’s age, net worth and strong earning power suggest he can take on an asset mix profile such that his portfolio will be skewed towards equities with more risk of loss than if he were to buy safe government bonds and hold them to maturity. That, in turn, suggests a 70% allocation to equities and 30% to fixed income. His investment horizon is very long and so he can ride out cycles in the stock markets, says Graeme Egan, founder and president, CastleBay Wealth Management Inc., in Vancouver.

Instead of trying to outsmart the market by selecting a portfolio of stocks, or asking a portfolio manager to beat the market, Dreumon should consider a passive investment approach that will achieve solid long-term results at what is likely to be a lower cost. The strategy is simple: buy investment indexes packaged as exchange-traded funds with fees of 0.1% to 0.5% — a tiny fraction of the average 2.5% that equity mutual funds charge.

Egan’s recommended equity weightings for Dreumon’s portfolio are: Canada (30%), U.S. (15%), Europe (10%), Asia Pacific (10%) and emerging markets ( 5%). The remaining 30% should be divided between Canadian and U.S. fixed income. The weighted average return of these asset classes over the past 20 years is 7% a year. Assuming dividend income and capital gains are taxed at a combined marginal tax rate of about 25%, and bond interest is taxed at 45%, the overall weighted rate of tax would be about 31%. That leaves the Dreumons with a 4.8% return. Factor in inflation of 2% and the net is 2.8%.

The loan will cost 2.6%, but it is tax deductible so it would cost him about 1.4% after tax. An after-tax, after-inflation return of 1.4% would make the whole investment loan strategy work using a simple index-based approach to his long-term investment strategy. It is not a big return, but it is based on the lender’s money. If loan rates should rise above returns, the Dreumons could sell their index ETFs and pay off the loans. Moreover, the loan will be easier to carry as time goes on and their monthly mortgage payments build up equity.