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Facelift for April 03, 2010.

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When the stock market crashed in late 2008, Marlene panicked and pulled her money out of mutual funds.

Because she has no company pension, Marlene will be relying entirely on her savings when she retires, which she hopes will be in about four years. She is now 56.

She has a well-paying job in engineering consulting, pulling in $118,000 a year before taxes. She owns her condominium in suburban Vancouver outright and has an interest in some land. As well, she has more than $710,000 in savings.

But the fear of losing money is threatening her retirement security because interest rates on term deposits, where most of her money is stashed now, are at historic lows.

"How can I balance risk and my relatively short time frame?" she asks in an e-mail. "I do not want to find myself short 10 years down the road. I would like to know how to best weather future storms."

We asked Bryson Milley, a financial planner at Rogers Group Financial in Vancouver, to look at Marlene's situation.

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What the Expert Says The trick is to find the right balance between textbook solutions and Marlene's stomach, Mr. Milley says.

"Not only does [a plan]have to be logical, but it has to feel right."

If Marlene retired today, she would need $38,130 a year after tax, based on her current expenses, the planner estimates. Because she will have more time to spend on her hobbies, she will likely need a little more, so Mr. Milley has revised the required amount of estimated income to $42,000 a year, or $3,500 a month, in today's dollars. Assuming a 3-per-cent inflation rate, by the time Marlene turns 60 this number will have increased to $47,270.

Marlene is in a very strong financial position. Her total invested assets are valued at $710,800, she has no debt of any kind, and she is saving an additional $46,000 a year.

Assuming she works for another four years, she can save an additional $184,000 before tax deductions and/or investment returns, Mr. Milley estimates. This, assuming a 6-per-cent growth rate, will raise her total savings to about $1.1-million.

Given Marlene's bad experience with the market, Mr. Milley looks first at how she would fare with her entire portfolio invested only in guaranteed investment certificates. He assumed a 3-per-cent inflation rate and an average annual return of 5 per cent a year. From her $1.1-million of retirement savings she would then draw about $33,000 a year from principal and interest after tax in today's dollars.

If she began collecting Canada Pension Plan payments at age 60, she would have another $500 a month, lifting her total after-tax income to $39,500 a year. That is $8,270 a year short of her estimated income need of $47,270.



The Invest for Life series:

  • Part 1: Ten money tips for young people
  • Part 2: Ten money tips for people entering the work force
  • Part 3: Getting married? Ten money tips
  • Part 4: Having kids? Pull out the wallet and get set to invest for the future
  • Part 5: Married, with kids? Ten investing tips
  • Part 6: Financial tips as you climb the financial ladder
  • Part 7: Preparing for retirement: 10 tips
  • Part 8: The retirement years: 10 financial tips

Because Marlene is nervous about being entirely in marketable securities (stocks and bonds), Mr. Milley recommends a tactical, three-tiered approach that would allow her to take more market risk while at the same time protecting her assets from a major market correction.

Tier 1 would be $42,000 of cash to cover her income need in her first year of retirement. This portion would be invested in money market instruments and/or a daily interest savings account, whose return would equal the rate of inflation. From this she would draw $3,500 each month, and she would also collect CPP of about $6,000 a year.

Tier 2 would be $170,000 - enough to provide three-plus years of income - in her RRSP and TFSA invested in three-year GICs and/or a bond ladder, in which a certain amount of bonds or GICs come due each year. This tier should be arranged so that one-third or $63,500 matures annually and is invested to provide a real rate of return, after subtracting inflation, of 2 per cent.

Finally, tier 3 would be her long-term investment portfolio of about $888,000 appropriately balanced between stocks, bonds and other securities and held in both her RRSP and non-registered accounts in order to minimize income tax. The targeted real rate of return would be 4 per cent.

Each year, Marlene would evaluate how tier 3 had performed. If it had made any profits, the next year's income need will be redeemed from this account and put into tier 1 for the monthly payments. If tier 3 makes more than the income required for the following year, the residual profit would be added to tier 2.

"Tier 2 is the portfolio's insurance policy," Mr. Milley says. " We know that there are going to be years when Marlene's [tier 3 portfolio]will lose money. In these years the following year's income will be taken from tier 2, which will have not lost money."



Client Situation

The Person:

Marlene, age 56

The Problem:

Protecting her nest egg from another financial market meltdown while still earning a decent return.

The Plan:

Set up a three-tiered savings program so that long-term investments such as stocks and bonds can be left untouched for up to three years.

The Payoff:

More income in retirement than would be offered by term deposits or guaranteed investment certificates.

Monthly net income:

$7,010

Assets:

Condominium $350,000; rural lot, $94,000; RRSP $303,000; TFSA $5,000; non-registered savings $403,000. Total $1,155,000

Monthly disbursements:

Food $235; clothing $165; transportation $225; other living expenses $125; home insurance $45; property tax $140; maintenance fee $485; utilities, cable, Internet, phone $135; other home expenses $15; vacation $500; entertainment $100; gifts $135; charity $790; medical/prescription $80; RRSP savings $1,750; non-registered savings $2,085. Total $7,010

Liabilities:

None

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