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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 ...

Some retirees like the sun and sand of the U.S. sunbelt to ride out Canada’s frigid winters, but not Teresa. The 57-year-old retired public servant prefers the coast of West Africa.

Yet she isn’t vacationing. Instead, she sold her home in Winnipeg 18 months ago to volunteer overseas helping others for the next decade.

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“Sharing my time, talent and treasure is what makes me feel whole,” she says.

Teresa’s expenses today are about $1,040 a month, which is much less than the $2,501 net income she receives from her work pension.

“Of that, I give away about $300 per month to people in need, and there’s lots of need here,” she says, corresponding by e-mail from aboard a volunteer aid ship docked off the coast of Guinea.

Teresa says she has an investment portfolio “nearing $300,000” with TD Waterhouse, a unit of Toronto-Dominion Bank. She is a balanced investor who has 8 1/2 years for her money to grow, at which time she will be 65, plans to return to Canada and will need her investments to provide a steady flow of cash to supplement her work pension, Canada Pension Plan and Old Age Security incomes.

The portfolio is slightly oriented toward growth and contains four so-called “fund of funds” – mini-portfolios containing at least 10 mutual funds each. Most of the funds invest in high-quality government and corporate bonds and blue-chip stock.

“Based on what TD Waterhouse has put together, with my public-sector pension, my expectation is to have an income stream of $60,000 to $80,000 [a year] by age 65,” she says.

Still, Teresa says she isn’t a sophisticated investor and doesn’t know if the portfolio is right for her. “I wonder whether my investments are on track to reach my income goal?”

For advice on Teresa’s portfolio, we turned to two Winnipeg-based wealth managers – Uri Kraut, a financial planner and senior wealth manager with Assiniboine Credit Union, and financial planner and portfolio manager Doug Nelson with Nelson Financial Consultants.

The basics

$126,600 Non-registered accounts (TD Managed Income & Moderate Growth Portfolio, TD Target Return Balanced Fund).

$74,000 Registered retirement savings fund (TD Managed Balanced Growth Portfolio).

$16,700 Tax-free savings account ( TD FundSmart Managed Balanced Growth Portfolio) .

Uri Kraut’s tips

1. Teresa’s income goal expectations are not properly aligned with her investment strategy. First, her portfolio is less than she realizes. The total value is about $217,000, not $300,000. Based on a 4.75-per-cent return net of fees, her portfolio would be valued at about $314,000 in about eight years. If she is able to contribute $500 a month to her non-registered and TFSA while volunteering overseas, Teresa could increase her portfolio by about $63,000. Yet it’s unlikely her portfolio in eight years would be able to sustain even the low end of her goal – $60,000 gross a year – because she would need to withdraw $24,000 a year from her savings. At that rate, her money would last until her early 80s at best and less than 10 years in a worst-case scenario. Throwing around income goals with as wide a range as $60,000 to $80,000 a year and not knowing her portfolio’s value are likely indications she and her adviser are not on the same page – precisely why she needs to have a clear plan.

2. Teresa owns only funds managed by TD sold to her by a TD adviser, which begs the question whether she is being sold the best funds possible for her needs. Because the portfolio’s performance is, at best, average, the answer is likely no. The trailing returns for her overall portfolio over one year, five years and 10 years are all below the benchmark in large part because of the fees she pays for management. The management expense ratio (MER) for the entire portfolio is 2.46 per cent. Higher management costs are not necessarily a bad thing if the management actually outperforms its benchmark over time, but this isn’t the case. The high fees are even harder to justify when we take into consideration that half the portfolio is invested in bonds, making it difficult for her investments to produce a return net of fees and taxes that keeps ahead of inflation. For example, if her bond investments held in her non-registered account average 4 per cent a year, the net return after taxes and fees would be about 0.5 per cent. With an inflation rate of 2 per cent, the return is negative.

3. Teresa’s portfolio isn’t as diversified as it may appear. Although the “fund of funds” strategy claims to provide diversification by investing in many funds that are themselves diversified in many investments both geographically and by sector, the reality is this strategy has created a situation in which Teresa’s portfolio holds many funds that own the same investments with similar asset mixes. In other words, they are highly correlated to the same market risks. This is the opposite of diversification, which is intended to de-correlate assets in the portfolio so when some investments are affected by a downturn, others are less affected or, ideally, perform well. Teresa would likely be better off owning five to eight top-performing mutual funds as her entire portfolio. This strategy is more streamlined than the current structure of four mini-portfolios, each containing at least 10 mutual funds or exchange-traded funds. This smaller, more simplified portfolio provides a better understanding of whether her investments can yield the return necessary to meet realistic income needs down the road.

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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