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Investing strategist Dan Hallett suggests that cheap housing makes his home city of Windsor, Ont., a good place to retire. (GEOFF ROBINS For The Globe and Mail)
Investing strategist Dan Hallett suggests that cheap housing makes his home city of Windsor, Ont., a good place to retire. (GEOFF ROBINS For The Globe and Mail)

PORTFOLIO STRATEGY

Downsizing? A plan to invest the proceeds carefully Add to ...

Sell Oakville, buy Windsor.

Investing strategist Dan Hallett has been saying this to friends of his lately: With an eye on retirement, sell your home in Oakville, about an hour’s drive west of Toronto, and head another three hours west on Highway 401 to his own city of Windsor.

“I only half-jokingly tell them, look, it’s a nice house, but compared to what you’d find in Windsor there’s probably a $300,000 difference,” said Mr. Hallett, vice-president at HighView Financial Group.

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“You could add a lot to your retirement account with that, or you could retire sooner. Think how long it would take even people with good-paying jobs to earn $300,000 after taxes.”

Personal savings, pensions and government programs will be the foundation of your retirement income, not your house. Still, there is an opportunity to improve your financial position by downsizing your home in retirement and investing what’s left over.

Unless they move to a much cheaper city, Mr. Hallett thinks most people will find they have overestimated how much money they’ll free up for retirement in downsizing the family home. He said retirees often find that the cost of smaller dwellings like condos and townhouses is reasonably close to the value of their family homes in the same or a comparable city.

Let’s be optimistic and strategize on how a couple might invest $100,000 left over after downsizing and payment of all related costs, like legal fees and a mover. Mr. Hallett suggests a first step of considering their goal for that money. Will it be to generate investment income on an ongoing basis to supplement their savings, or to act as a block of savings that they can dip into gradually over time?

If you want income, be prepared for disappointment. Interest rates are low, and so are the dividend yields offered by many blue-chip stocks. That’s a function of the multiyear stock market rally – rising stock prices mean falling dividend yields.

Might you be able to swing a monthly pretax income of $400 from your $100,000 portfolio? To do that and not touch your principal, you’d need a mix of investments with an overall yield of 4.8 per cent after fees that can be estimated at 0.5 per cent for exchange-traded funds held in a do-it-yourself account at an online broker and 2 per cent for products held through an adviser.

This suggests a gross yield in the 5- to 6-per-cent range, which is unworkable without holding investments with a very high risk level. You need still higher gross returns if you wanted a buffer against inflation in your monthly income.

A monthly income of $200 to $300 seems realistic in today’s market if you use the kind of low-cost dividend or income ETFs I wrote about in this installment of my ETF Buyer’s Guide earlier this year. “Certainly, keeping your costs low is going to help in getting as much cash flow as you can,” Mr. Hallett said.

A much different approach is called for if you want to use what’s left after downsizing your home as a savings fund. For example, you might want to use the money to finance a nice vacation every couple of years or to help your kids with a house downpayment.

Mr. Hallett suggests going through a budget-like exercise where you figure out how much each of your goals will cost, and when you’re going to need the money. A rule he supports is to put money you anticipate spending in three to four years or less in a high-interest savings account.

Avoid the stock market for money you’ll need in the short term, he stresses. “If you think of your typical bear market scenario, you’re talking about losing one-third of your money [from market peak to trough] and being underwater for about three years.”

Let’s say you want to allocate $50,000 to helping your kids buy a house and $20,000 for trips or other expenses in the next three years. That’s $70,000 in high-interest savings accounts, which currently offer rates of close to 2 per cent while offering the protection of Canada Deposit Insurance Corp. Online bank Canadian Direct Financial, a division of Canadian Western Bank, offers 1.9 per cent, while Peoples Trust pays 1.8 per cent. These are ongoing rates, not temporary teasers.

Mr. Hallett suggests the final $30,000 go into a balanced fund, with the proviso that the money is set aside for longer-term needs and won’t be needed in less than five years. His take on three funds that could work well for this job:

1.CI Signature High Income: Comparatively low fees and a somewhat aggressive investing approach.

2.Mawer Tax Effective Balanced: Low cost and well diversified; designed to be tax-effective for non-registered accounts.

3.RBC Monthly Income: Low fees for this type of fund; has less global diversification that the other two funds listed here.

Houses can be sold tax-free, as long as they’re your principal residence. But the money you invest from selling your house may generate taxable dividends, interest and capital gains. One way to minimize these taxes is to invest as much of your house-sale proceeds in a tax-free savings account. The problem with TFSAs is that there’s not a lot of contribution room. The limit for 2014 is $5,500, and the limit retroactive to 2009 if you’ve never used one of these accounts is $31,000 per person.

Another idea from Mr. Hallett is to consider tax-effective funds, like the Mawer product mentioned above or corporate class mutual funds and ETFs. These funds may allow interest income to be converted into dividends or capital gains, both of which are less heavily taxed than interest.

In retirement, the net gains from downsizing your family home are likely to be the only financial windfall you get. Invest carefully.

 

Globe app users click here for a chart showing an investment plan for downsizing retirees

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