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(Dushan Milic For The Globe and Mail)
(Dushan Milic For The Globe and Mail)

PORTFOLIO MAKEOVER

Is volunteer’s portfolio as good as her deeds? Add to ...

Doug Nelson’s tips

1. Before Teresa can build a well-designed portfolio, she must understand her tax situation. As an international volunteer, she is still a Canadian resident so income produced from her non-registered portfolio is fully taxable, but she may be eligible for special tax credits specific to overseas volunteer work that can help reduce her tax burden. Those potential tax savings aside, her portfolio does not appear to be designed for tax efficiency. Her non-registered portfolio comprises of 55-per-cent fixed income, so interest earnings from those investments will be taxed at her marginal rate.

In contrast, her RRSP portfolio is more growth-oriented, and its 60-per-cent equities structure makes it better suited for a non-registered account because dividends and capital gains are taxed more favourably than interest. For tax-efficiency, interest-bearing investments – like bonds and guaranteed investment certificates – should be held inside the RRSP because they earn interest tax-deferred until withdrawn, at which time the money is fully taxable. If set up properly, however, the initial investment is contributed with earnings that would be taxed at a higher rate when working and withdrawn at a lower rate in retirement. In contrast, dividend-paying equities and capital gains receive favourable taxation, so they are best suited – for her situation – in the non-registered account where they will be taxed at about half the rate they would be if withdrawn from the RRSP.

2. Teresa needs to build a more realistic plan for when she returns home in eight years. She should ask herself how much more cash flow will be required over and above her pension, Old Age Security and Canada Pension Plan income to support her desired lifestyle. The answer will drive her investment strategy, providing a better idea of how much market return she will need from her portfolio and what investments can best provide that performance. Yet the investment strategy must also be suitable for her appetite for risk. Given her short timeline, Teresa may be more conservative than her current portfolio suggests. Although her portfolio does need to grow, preserving capital is likely a priority because she will need at least half her money to buy a condo. Only her non-registered and TFSA accounts – about $150,000 in total – will be available for that purpose because a lump-sum RRSP withdrawal would likely be taxed heavily. Based on her present portfolio, which may be too risky, her TFSA and non-registered investments would be worth $246,000 nine years from now –and that is based on a somewhat optimistic 6.8-per-cent annualized return. If that’s not enough, she will need to use some of her monthly income cash flow for a mortgage payment. Teresa may be better off with a more conservative approach focusing on wealth preservation, and instead of seeking higher investment returns, she saves more every month in a systematic, tax-efficient way guided by realistic income needs.

3. Teresa has enough investable assets to command better advice and service. Her current portfolio suggests she is not getting the best bang for her buck in this regard. Her adviser’s investment strategy appears to be a set-it-and-forget-it plan, based on the assumption she has 8 1/2 years so she can afford to be a little more aggressive with her money. Yet this “buy low, hold and sell high” strategy may work well in bull market conditions because it ignores the potential market risks associated with the current environment of high stock market volatility and low interest rates. Teresa can do better. She even has enough assets to even hire a professional money manager who can make buy and sell decisions on her behalf based on her unique circumstances. If it appears the world is coming to an end and she really needs to hold more cash, then a money manager can make that decision. Her current adviser – essentially a mutual fund salesperson – does not have that discretionary authority. Furthermore, the management cost of personal portfolio management would be about 1.5 per cent of assets a year as opposed to the more than 2 per cent she is currently paying.

You can get your portfolio reviewed by the experts, too. Send us a confidential e-mail to portfoliomakeover@globeandmail.com. If we profile your portfolio, your identity will not be revealed.

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