Time to retire the high-risk strategy

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Harry and Sally are in the enviable position of working for themselves as employees of their own corporation.

They've been successful, amassing $1.8-million in investments. Their Toronto home is valued at $500,000.

Even so, their goals differ little from those of other working people. They want to retire early - in their case in two or three years - work part-time, fix up their house a bit and arrange things so they can live comfortably from their investments for the rest of their lives. He's 59, she's 53.

They have no children, so they hope to leave a financial legacy to their favourite charities.

They invest through a discount stockbroker in individual stocks and keep a cash reserve of 10 per cent to 25 per cent of their portfolio. They've done well, chalking up a return of 8.5 per cent a year over the past dozen or so years.

"Therefore, I hope to compound 8 per cent, including inflation, in retirement," Harry writes in an e-mail. They figure they'll need about $100,000 a year after tax when they retire because they expect to spend about the same amount of money then as they do now. "We would appreciate feedback about our budget and plan."

We asked Warren MacKenzie, president and chief executive officer of Weigh House Investor Services in Toronto, to look at Harry and Sally's situation.

What the Expert Says

Sally and Harry are unlikely to run out of money if they manage it prudently, Mr. MacKenzie says. But their high-risk investing style could undermine their plans. Bad investment decisions now could result in a lower standard of living in retirement and reduce the likelihood of leaving a substantial gift to charity.

Although Harry fancies himself a good stock-picker, Mr. MacKenzie says the couple's portfolio is risky and poorly diversified among asset classes.

"They have 84 per cent in equities with the balance in cash." Nearly 40 per cent of the stocks are in small-capitalization companies, many of them penny stocks. Roughly 40 per cent of the portfolio is in the industrial sector, which comprises only 8 per cent of the S&P/TSX composite index.

As they move into the retirement phase of their life, they should shift their investment strategy from aggressive growth to capital preservation.

"The high-risk strategy that enabled them to build a large portfolio is not the right one to help them preserve capital during their retirement."

Part of the problem is that Harry believes they need to earn an average annual return of 8 per cent to meet their spending goals, Mr. MacKenzie says. In truth, they can likely get by with a return of 5 per cent because they will spend less when they are retired than they do now. If they can't, they should plan to trim their spending.

As well, an 8-per-cent return is very difficult to achieve year in and year out.

"It is very easy to plug a higher return into a financial plan; it is considerably more difficult to achieve it."

Mr. MacKenzie recommends a long-term asset mix of about 50 per cent in fixed income investments and 50 per cent in stocks. That way, the couple would be much less exposed to downturns in the stock market. About a third of the portfolio should be in short-term bonds.

To broaden their equity holdings, they could buy some exchange-traded funds, "which provide instant diversification, simply and cheaply," for their core holdings, the planner suggests. Harry could manage a small portion of the assets using his current strategy.

Alternatively, given their substantial assets, they could hire a professional money manager or investment counsellor. Unlike stockbrokers, investment counsellors have a fiduciary relationship (like a trust company) with their clients.

It is a good idea to establish a relationship with a professional money manager now, so if and when Harry no longer feels like making investment decisions, or if Sally is left on her own to make them, they will already have a long-term relationship with a firm they trust.

Over the 30- or 40-year span of their lives after they quit working, either one could face health problems that might require nursing home care or medical costs that may not be adequately covered by government programs. They can prepare for this through critical illness health coverage or by investing and spending in such a way that they will always have a financial cushion.

Finally, $480,000 of their capital is held in their jointly owned corporation, which will become a holding company when they retire, Mr. MacKenzie notes.

They "should speak to an insurance agent about the possibility of using corporate-owned insurance to reduce the tax bite that will be triggered as this money comes out of the company and is spent by the surviving spouse."

Client situation

Special to The Globe and Mail

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