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David Smith for The Globe and Mail
David Smith for The Globe and Mail

Financial Facelift

Great expectations, limited means Add to ...

Nancy lives in an idyllic setting in rural Nova Scotia, but at 59 her thoughts are turning to the day when she might leave her restored farmhouse and garden to be closer to her two children in Ontario.

Such a move would strain her budget despite her public service pension.

“Living in the country brings with it advantages and disadvantages,” she writes in an e-mail. Not only does she have a lovely old house and barn on five acres of riverfront, but her property taxes are low. Still, keeping a car is costly and in time the work could become a burden.

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“I cannot realistically expect to be able to keep up forever with the physical demands of heating with wood, snow removal, house maintenance, tilling the garden ...,” she writes. Her concerns are twofold: The federal government may decide to do away with pension indexing, so she would lose purchasing power over time; and her investments have been lagging.

“I know that there are many women of my age who have no one but themselves to rely upon to make the right decisions to maintain their financial independence,” Nancy writes. If and when she moves, Nancy will sell her house and the waterfront lot she owns on the Eastern Shore, which will add to her investment capital.

But can she afford to move to a province where housing is so expensive?

We asked Warren MacKenzie, president and CEO of Weigh House Investor Services in Toronto, to look at Nancy’s situation. Weigh House is a fee-only financial planning firm that does not sell investment products.

What the expert says

Nancy’s mutual funds have been underperforming their market index benchmarks by more than two percentage points a year for the past three years, Mr. MacKenzie says. This is largely because of high management fees and a “lack of any sound investment strategy.” On average, her funds have returned 12.1 per cent over three years, compared with 14.2 per cent for the benchmarks. Over five years, though, her average annual return has been a scant 0.8 per cent.

Once Nancy sells her house and building lot and invests the proceeds, her portfolio will be about $470,000 after expenses, so lagging the market by two percentage points will cost her about $10,000 a year – “the difference between financial security and running out of money in her old age,” the planner says.

If she can turn this situation around and make an average annual return of 5 per cent on her investments over time, she could meet all her goals even if her pension benefits are cut back, he notes.

Nancy is living on about $35,000 a year, a number that is covered by her pension income. If she moves to Ontario, she estimates she will need about $50,000 a year for living expenses.

“The reality is that if her investment portfolio continues to underperform, and if her pension ceases to be indexed, she would run out of money if she moved to Ontario,” Mr. MacKenzie says. If her pension continues to be indexed, she could get by with a return of 4.5 per cent. If it was no longer fully indexed, she would run out of savings in 30 years at a 4.5 per cent return.

Nancy`s first step should be to sit down with an adviser and draw up an investment policy statement that sets out target allocations for each different asset class and the reasons for recommending a particular asset mix, Mr. MacKenzie says. This statement will outline the acceptable range for each asset class and guidelines for rebalancing the portfolio as well as making tactical shifts to the upper or lower ends of the range.

“When she commits her plan to paper, it will help her manage her response to wild market swings,” the planner says. “A simple ETF [exchange-traded fund] portfolio adjusted occasionally according to the investment policy statement will achieve this goal.” He agrees with Nancy’s target allocation of 60 per cent equities and 40 per cent fixed income. Although she may not realize it, her current equity component is 68 per cent.

Holding single asset class ETFs will not only make it easier for Nancy to rebalance her holdings, but also for her to hold her fixed-income securities in her registered retirement savings plan and stocks in her non-registered portfolio, which is more tax efficient.

____

CLIENT SITUATION

The person

Nancy, 59



The problem



How to make enough money on her investment portfolio to cover the higher cost of living in Ontario.



The plan



Draw up an investment policy statement, then shift from high-cost mutual funds to lower cost exchange-traded funds, rebalancing the portfolio as needed. Hold fixed income in RRSP.



The payoff



Investments that are less risky, easier to monitor and that keep pace with the market without being eroded by high management expense ratios. If she can make 5 per cent on average, she'll have enough to cover her move to Ontario.



Monthly income



Pension $3,455; casual work $925. Total: $4,380.



Assets



Cash and short term deposits $40,000; TFSA $10,000; non-registered portfolio $63,440; RRSP $121,010; building lot $100,000; home $150,000. Total: $484,450.



Monthly expenses



Property taxes $20; utilities $160; firewood $50; house insurance $80; maintenance $180; gasoline $320; car maintenance and insurance $340; groceries $300; gifts $135; dining out $135; drugs, glasses $110; clothing $230; charitable $85; grooming $15; telephone $40; satellite $160; fitness club $30; vacations $185; entertainment $60; beverages $90; cash $140; income tax $275; bank charges $15. Total: $3,155.



Liabilities



None



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