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Paul has shed despair – should he now get rid of his adviser?

Dushan Milic/The Globe and Mail

There's a big difference between depression and the blues. Paul can attest to the toll that ongoing feelings of despair take on every aspect of a person's life. Now 60, Paul has been unable to work since he was 45 because of a major depressive disorder.

"I've had a long bout of depression and a couple of nervous breakdowns since 1999," Paul says. "Fortunately, I can report that I've been off medication for about a year and hope to never have to return to that black hole. …There were some pretty scary moments. I'm trying to do the best I can each and every day."

It's not just his career that has suffered. Paul says that because of the way mental illness completely consumed him, his finances have been affected as well. He has also lost faith in the financial-advisory field.

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"Being heavily medicated, I simply allowed my financial adviser to steer the ship," Paul says. "I've come to realize that high management-expense ratios [MERs] and trailer fees were the diet of my financial adviser. I had made some suggestions earlier this year toward funds with lower MERs and was met with resistance."

A former investigator in the criminal justice field, Paul has no debt, a disability pension and full medical benefits, and he'll soon be collecting early CPP and later a fully indexed defined benefit pension. His expenses vary, but he describes himself as frugal.

His goal is to create a tax-efficient income stream with minimal fees. For him, income preservation is more important than growth.

To help him reach those aims, we consulted Vancouver certified financial planner Laura Chanin of DWM Securities Inc., and Nancy Grouni, a certified financial planner at Toronto's Objective Financial Partners.

The basics

Assets

– House: $1-million

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– Cash: $160,000

– Tax-free savings account (TFSA): $30,000

– Self-directed RRSP: $244,000

Expenses

– $4,000 a month or less

Ms. Chanin's tips

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1. Restructure funds to be more tax-efficient and less aggressive.

Ms. Chanin notes that Paul is in a good place financially, but there's room for improvement. "He has a fully indexed defined benefit government pension that covers over 80 per cent of his expenses. He is about to start CPP, which should provide another $350 per month for the rest of his life."

However, Paul currently has his non-registered funds in cash and most of his tax-free savings and RRSP in equities. "It is more tax efficient to switch this, that is, to have equities and dividend-paying investments outside of RRSPs, and cash and investments that generate interest income – such as bonds and term deposits – inside an RRSP," Ms. Chanin says. "This is because capital gains and dividends get preferential tax treatment outside of an RRSP or TFSA. Interest income is taxed fully outside of an RRSP, the same tax rate as RRSP withdrawals."

All of his TFSA funds are invested in one equity fund that focuses on Asia only, Ms. Chanin notes, while his RRSPs consist of about 60 per cent equities and 40 per cent bonds and cash.

"This is fairly aggressive and leaves him subject to ups and downs in the market," she says. "As his focus is to now provide a stable income, a better balance for Paul would be to split 50 per cent of his investments into dividend-paying blue-chip equities and 50 per cent into a portfolio of secured investments, such as laddered term deposits, possible annuities, etc. He could expect a steady, secure income."

2. Reduce fees.

"Within his mutual funds, the MER is about 2.4 per cent, which is about average for Canadian mutual funds," Ms. Chanin says. "Given his limited investment skills, ideally he would continue to work with an adviser. He could talk to different advisers to find the best fit and to talk about different fee options. He could work with an adviser who offers fee-based accounts. The fees are typically lower than MERs, and, for non-registered accounts, the fees are tax deductible.

3. Use resources more wisely.

Paul has been actively withdrawing $30,000 a year from his RRSP in anticipation of avoiding OAS clawback at age 65.

"At this rate of withdrawals, the RRSPs will be gone in the next eight years," Ms. Chanin says. "This isn't the most efficient way of utilizing his resources. His current income of about $66,000 puts him at a marginal tax rate of just under 30 per cent. For income withdrawals above $75,000, he is paying tax at a 32.5 per cent rate, and for income above $87,000, he is paying tax at a 38 per cent rate.

"The OAS clawback starts to reduce at $70,594 and is fully gone when your income is $114,600," she adds. "Paul should reduce his RRSP withdrawals to $20,000 per year, which would save $3,800 tax per year. He may lose a slight bit of OAS, but this is more than made up for by the tax savings."

Ms. Grouni's tips

1. Find right investment option.

Given that there's no such thing as "one size fits all" when it comes to investing, Ms. Grouni says Paul needs to decide whether he wants to be a DIY investor or find an adviser with whom he's comfortable.

"If he feels he's capable of managing his own portfolio, he can open an online account directly with a low-fee mutual fund provider," she says. "By foregoing planning services, investors can reduce costs to about 1 per cent for bond funds and 1.5 per cent for equity funds, or even less. Do-it-yourself investors can reduce their fund costs even further by opening an account with a discount brokerage. He'll have access to a wider array of funds."

If Paul chooses the adviser approach, on the other hand, he needs to find one who will listen to his needs and help build a portfolio that's in line with his risk tolerance, time horizon and investment goals.

"It's also a good idea to ask for a few sample portfolios that represent a cross section of their current holdings," Ms. Grouni adds. "This will give you an idea of how they build portfolios. Your adviser should ensure your funds are in the most tax-efficient accounts, holding fixed income in registered accounts and preferentially taxed dividends and capital gains in non-registered accounts."

2. Reduce the fees.

"Paul's frustration with his holdings is certainly understandable," Ms. Grouni says. "An analysis of his portfolio reveals that the MERs levied by the various funds he owns range from 2.39 per cent to 3.08 per cent. In all, he is paying about $7,200 – representing an average of 2.6 per cent – in annual MER costs. Most of that cost covers investment and management fees incurred by the fund, while about 1 per cent, known as the trailing commission or trailer, goes to the adviser for ongoing service.

"Unfortunately, it's not often true that funds with higher MERs offer better performance," she adds. "Assuming a conservative portfolio returns 5 per cent per year before costs, a 2.5-per-cent MER would erode 50 per cent of Paul's return, leaving him with an unimpressive net performance number that hovers around the inflation mark."

Although worthwhile mutual funds exist, Paul might consider investing in exchange-traded funds (ETFs), Ms. Grouni notes.

"While most mutual funds are actively managed funds, trying to outperform the market, ETFs in Canada are mainly passively managed index investments," she says. "Their goal is to track the performance of a broad market or benchmark or a specific selection of it. What makes ETFs so appealing, in part, is that they charge a small percentage when compared to many mutual funds. By making the switch, Paul would save approximately $5,000 per year or more, representing an 80-per-cent savings in MER costs versus his mutual fund portfolio."

3. Plan, then enjoy retirement.

Despite Paul's health challenges, he's in great shape to enter retirement, Ms. Grouni says. "Even assuming $5,000 net per month in expenses and an annual 2 per cent inflation rate, he will need to tap into his savings only to the tune of about $12,000 to $13,000 per year, until his OAS kicks in in seven years. Once he starts withdrawing from his Registered Retirement Income Fund (RRIF), he will actually have surplus income. His projected net worth at retirement, assuming an overall rate of return of 4.5 per cent net of fees, is approximately $2.6-million."

All of this means that Paul will have a great deal of flexibility to pursue other interests and ventures. "It might be helpful to remember, however, that whether he wants to take that African safari, travel the globe, or golf every day, planning when he wants to pursue these interests is as important as assessing the financial cost of doing so," she adds. "Make sure you see the forest through the trees during your retirement by budgeting for those luxuries, especially in your earlier retirement years."

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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