A portfolio that is spinning out of control

SITUATION Couple with good pensions has muddle of investments with unreasonably high fees STRATEGY Cut investments to a few low-cost funds with predictable returns, hire a single advisor SOLUTION More reasonable investment costs, income that keeps up with

Albertans we’ll call Sam, 58, and Martha, 53, have had terrific careers in large organizations. Sadly, they have not carried that success into their preparations for retirement. Sam spent his career at a high-tech manufacturer, Martha in the Alberta provincial government. Neither gave much thought to investing.

The result is that they have squandered much of their savings on investment flops like Nortel Networks which they held to the bitter end and high-fee mutual funds that have been good to their managers and to the people who sold them but not to Sam and Martha. The question now is whether they can recover sufficiently to have a retirement without sacrificing their present way of life.

At first glance, they have done well, accumulating approximately $1.1-million in financial assets and rental real estate. They have a $500,000 house, a couple of cars, two children finishing university with sufficient RESPs and relatively modest liabilities of $80,000 — just a couple of mortgages for their rental properties. Their monthly takehome income from their jobs and rental properties is $10,139.

Their issue is the uncertainty of age, for they are in transition from their active careers to what they see as the passivity of retirement when they no longer control their finances. The problem is partly psychological and partly financial. The two problems are linked, for they must learn to manage or at least learn who should manage a portfolio that is spinning out of control.

“I want to retire as soon as possible, perhaps at age 55,” Martha says. “But I’m getting cold feet. Am I financially able to retire at 55 without having to dip into our assets? If we did do that, would we have enough money to pay for extended care if we require it in the future?”

Family Finance asked portfolio manager and financial planner Adrian Mastracci, head of KCM Wealth Management Inc. in Vancouver, to work with Sam and Martha.

In his view, they need not worry about having enough money.

“They want $100,000 per year before tax in 2013 dollars when they begin retirement,” the planner says. “They will have work pensions — Sam’s $48,000 and Martha’s $20,000 per year, $20,000 in real estate rental income, and should be able to harvest 2.5% or $11,000 per year from $440,000 in financial assets. That’s $99,000 — close enough.”

When each hits 65, it will be possible to take Canada Pension Plan benefits, $12,150 for Sam and $8,100 for Martha. Sam can have Old Age Security benefits, currently $6,553 per year, when he is 65, Martha at 66.

At that point, their retirement incomes would be $132,356 before tax. With pension splitting, each would have $66,178 before tax, less than the $70,954 net taxable income trigger point for the OAS clawback in 2013.

After tax at an average rate of 30%, they would have $7,720 per month to spend. That would easily support present spending shorn of retirement savings and debt service. The problem will be keeping up with inflation. Their largest work pension, Sam’s $48,000 per year, is not indexed to inflation. Martha’s smaller $20,000 pension is only partially indexed.

The real estate rentals may or may not pace inflation, depending on the state of the market. Worst of all, their financial assets’ ability to pace inflation is being eroded by high mutual fund management expenses.

A total of $430,000 of their financial assets in their RRSP, TFSA and taxable accounts is in 70 mutual funds, dozens of stocks and several GICs. Of the 70 funds, some with fees as high as 2.95% per year, there are 20 duplicates that pop up in more than one portfolio.

There is no pattern to the collection, no evidence of planned asset allocation, no investment strategy, and no one at the helm of the whole collection. One cannot say how it will move in reaction to market or macroeconomic forces. It is vast and it is out of control, Mr. Mastracci adds.

Sam and Martha were frugal in saving money, but they have been careless in investing it. “Whenever we accumulate enough savings, we purchase an investment.”

They have six current advisors, each of whom looks after some of the funds he sold. Those advisors appear to have had a taste for investments in biotechs, small airlines, leisure travel, theme parks, auto parts, small cap oil services and heavy construction.

“Their advisors appear to have used a shotgun to make their picks and then missed the target,” Mr. Mastracci says.

The obvious first move for the couple is to pick a single advisor to manage their stocks and funds. It should be a cost-efficient move.

Assuming that fees average 2.5% on their financial assets including RESPs, they are paying $11,500 a year for advice. A single portfolio manager might charge 1.5% and the portion attributable to taxable accounts would be tax deductible.

Cutting out the high-cost mutual funds and just buying exchange traded funds for all accounts including the RESPs, then switching to ETFs with management fees of 0.5% of net asset value or less would save them as much as $9,200 per year.

They could achieve those savings when backload penalties drop to 2% or less — which they could make up in a year or two of dividends or bond interest from a maximum of eight ETFs. Their savings alone would pay for a good deal of medical care, should they need it.

Mr. Mastracci suggests a portfolio of 40% stocks and 60% fixed income from ETFs that provide diversification at low cost. The stock ETFs should be 20% in Canada, 15% the U.S. and 5% global. Fixed income could be put half into an exchange traded fund with a one to five-year ladder of investment grade corporate bonds and half into an ETF of common stocks with a record of raising dividends every year or two for the last 10 years.

This portfolio would be likely to generate 2.5% in dividends and bond interest and 3% or more each year in the rising value of underlying stocks. On an asset weighted basis, the pre-tax total return of the portfolio would be 4.5% and would be self-indexed to gain 2% in real purchasing power if inflation runs at no more than 2.5% per year.

“In rebuilding their portfolio, they must have purpose, direction, cost control and, most of all, they must understand the risks they are carrying.”