MONEY MAKEOVER
Risk-averse Amy doesn’t know what to concentrate on: eliminating her mortgage or building investments,
The Person Amy, a 50-year-old legal assistant in Toronto, wants to retire in 20 years. She is single and has a 19-year-old daughter who lives with her ex-husband. Amy has never been entirely comfortable with risk; the stock market terrifies her. Still, she has built a respectable $221,000 portfolio in her Registered Retirement Savings Plan and $1,400 in her Tax-Free Savings Account. Amy also has a $137,000 mortgage on a condo valued at $255,000. The Problem Amy’s portfolio has everything from mutual funds with deferred sales charges to exchange-traded funds, but she has little understanding of whether this current asset mix will provide enough for her retirement needs in 20 years.
She recently fired her adviser for not reducing her many holdings. And she found his fees wiped out any gains she made from her investments.
Amy has $750 a month that she can either allocate toward investments or pay down on her mortgage more aggressively. So far, she’s taken the former approach. But keeping her mortgage payments the same means it won’t be paid off for another 23 years.
What should she concentrate on: mortgage elimination or building up more investments? The Plan Amy’s new adviser has set up a balanced portfolio. Ten per cent of her assets are in cash, 40 per cent in bonds and 50 per cent in equities. It’s an allocation that makes sense to Money Makeover featured adviser Robyn Thompson.
“Amy has a long time horizon with 20 years until retirement, so she is in a position to handle the risks associated with a balanced portfolio,” notes Thompson, a financial planner at Castlemark Wealth Management in Toronto. But besides having the ability to take on risk, “one also has to have the willingness and need to take the risk,” Thompson adds.
Amy has said she’s uncomfortable with the risk associated with equity markets. But she also needs to understand that there’s no free lunch. She would like to see her portfolio generate a 5 per cent rate of return net of fees — tough to do on a conservative portfolio. “To increase potential return, one needs to increase risk,” Thompson says. “I recommend Amy takes some more time to review risk tolerance and investment objectives with her new adviser to make sure the allocation aligns with her ability to tolerate risk.”
A possible solution is to reduce Amy’s equity exposure slightly, to 40 per cent from 50 per cent, increase her fixed income investments to 55 per cent from 40 per cent, and reduce cash to 5 per cent. “Amy does not require cash from her portfolio, and with the minuscule return on cash, she is better served with a lower cash allocation, cutting it to 5 per cent,” Thompson says.
As for paying down the mortgage versus investing, Thompson ran a few scenarios. If Amy were to increase her monthly mortgage payments by $750 she could pay off the mortgage in nine years instead of 23 years, and save approximately $32,000 in interest, Thompson calculates. With the mortgage paid off, if she redirected the $1,424 towards her RRSP, her account would grow to $503,000 assuming a 5 per cent rate of return.
But here’s the thing. If Amy keeps doing what she’s doing — paying the mortgage and investing the $750 a month toward her RRSP for the next 23 years, her RRSP would grow to approximately $568,000, based on the same 5 per cent rate of return. That’s $65,000 more than if she paid down her mortgage early.
But more assets aren’t the only factor in making the best decision for Amy.
“She will need to keep in mind that interest rates are at historical lows and will be higher in the future,” Thompson says. “She likes to invest in hard assets and paying down her mortgage may help her sleep better at night.”
Amy hopes to have $30,000 in annual retirement income after taxes. Thompson says the maximum she can expect to receive from Old Age Security and Canada Pension Plan is around $20,000 starting at age 65. Thompson recommends that she obtains a CPP Statement of Contri- butions through Service Canada and calculate her CPP at her intended retirement date (i.e. September 1, 2035.)
“She shouldn’t count on getting the maximum benefit — most people don’t qualify for it,” Thompson says.
The rest of the retirement money will come from her assets and Thompson believes she will have enough from her portfolio if she is able to achieve a 5 per cent rate of return. That said, she will need to keep a close eye on inflation as this will erode her purchasing power.