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portfolio makeover

Dushan Milic/The Globe and Mail

Retirement is just a couple of years away for Malcolm and Catherine. Yet the closer they get to the finish line, the more sleep they lose worrying about their portfolio.

"I fear if we don't look at changing our portfolio mix toward a larger growth component we could very well run out of funds too early," Malcolm says.

Aside from OAS, CPP and a small pension, the majority of their income will be drawn from a $600,000 RRSP portfolio invested in bank-managed mutual funds.

What worries Malcolm, 66, and Catherine, 64, is their portfolio's exposure to fixed-income investments.

About 55 per cent of their money is invested in bond funds, with the rest in equities. Although their adviser has assured them it's the right mix, Malcolm questions whether their portfolio contains too much fixed income.

"All of what I hear in the news is that bonds are going to get hit when rates rise, and we could stand to lose a lot of money."

Yet the alternative, investing more in the stock market, is not that appealing either. Already gun-shy after the 2008-2009 crash, Malcolm says they couldn't stomach another big downturn.

With a portfolio increasingly slanted to fixed income as they age, they worry whether their investments can provide the necessary returns to keep pace with inflation so they can maintain their lifestyle.

"We figure we need to make about a 4.5-per-cent return a year to provide a combined retirement income of $60,000 annually before taxes, but can we even count on getting 4 per cent with interest rates so low?"

Adding to their concern is a $70,000 debt on a line of credit that will not be paid off until they sell their home in about eight years. When they do eventually sell their $270,000 home in the Maritimes, they plan to invest the proceeds, using the money to help cover rent.

Winnipeg-based discretionary money manager Robert Tetrault, with National Bank Financial, and certified financial planner and investment analyst Chris Turnbull, with The Index House in Edmonton, have examined the couple's retirement portfolio and make the following recommendations.

The basics


– RRSP: $258,500

– LIRA: $210,500


– LIRA: $60,000

– RRSP: $73,200

– Work pension: $4,200 a year

– Home value: $270,000

– Debt: $70,000 on home equity line of credit

Mr. Tetrault's advice

1. Get professional, discretionary money management.

With more than $600,000 in assets, Malcolm and Catherine could hire a professional money manager to build a personalized portfolio to meet their retirement goals. A professional money manager would charge them about 1.5 per cent or less of their total assets annually, creating a portfolio of income-producing investments, including dividend stocks, preferred shares, bonds and REITs, that could address concerns such as rising interest rates and market downturns. Moreover, a discretionary money manager has a fiduciary duty – a legally binding obligation – to act in their best interest. In contrast, they have no such guarantee that their adviser at the bank will do the same, especially when they are entirely invested in bank-owned funds.

2. Keep the duration short and diversify the fixed-income holdings.

If Malcolm and Catherine are concerned about rising interest rates, they should ensure the fixed-income component of their portfolio consists of mainly shorter duration bonds, which are less negatively affected by rate hikes. The drawback with this strategy, however, is the yield on these investments will barely keep pace with inflation. To increase yield, they should look to diversify in other asset classes such as real estate investment trusts, infrastructure funds and floating rate notes. "There's very low volatility on these investments so they're way less likely to fall substantially in value in the course of one year."

3. Investing the proceeds from their house sale will be crucial.

Mr. Tetrault says the couple's savings should last until their early to mid-90s providing they sell their home in about eight years and, after paying off the line of credit, invest the proceeds to cover future expenses, including rent. The money should be invested in their TFSAs, which Malcolm and Catherine have yet to use. In eight years they will build up plenty of contribution room. With cost-of-living increases to the annual contribution rates, they could have as much as $100,000 each in unused TFSA contributions, Mr. Tetrault says, so most of the profit from the sale of their home would be tax sheltered, providing a tax-free income late into retirement. Using this strategy, their portfolio can sustain a combined after-tax income of $60,000 annually instead of $60,000 before taxes. "I upped their lifestyle just to be conservative and to pay rent when they sell their home," Mr. Tetrault says. "So they're actually okay for cash, believe it or not."

Mr. Turnbull's advice

1. Malcolm and Catherine may need a higher market return than they realize.

Almost half of the combined, pre-tax retirement income of $60,000 they require annually will come from Catherine's pension and their OAS and CPP benefits. The rest – about $33,000 – will be drawn from registered accounts over the next three decades. Whether a 4.5-per-cent return on their portfolio can sustain this drawdown depends on two factors: inflation and management costs. "Using after-fee, after-inflation returns of 2 per cent, 3 per cent and 4 per cent, the clients respectively need savings of $739,000, $646,000 or $570,000, in order to generate $33,000 income each year," he says.

In other words, if inflation is 2 per cent and fees are 1 per cent, they will need a market return of about 6 per cent annually from their $600,000-portfolio over the next 30 years to generate $33,000 of annual income.

One way to increase their likelihood of success is to reduce the fees they pay, using a portfolio strategy that invests in passive exchange traded funds (ETFs). The management costs on ETFs are a small fraction of those charged for mutual funds, and although a portfolio of index-tracking ETFs will not "beat the market," it will not underperform it either. Mr. Turnbull says since most actively managed funds fail to consistently outperform their benchmark indices; a portfolio of well-diversified, low-cost ETFs has a greater probability of achieving the 4.5 per cent they need than their current mutual fund portfolio.

2. Their investment mix is adequate as long as it is properly diversified.

Although it's understandable that this couple is worried about their portfolio's asset mix, the current 45-55 per cent split of equities and bonds has a high probability of providing them with more than their required returns over the long term if their money is properly diversified across five broad asset classes – bonds, real estate, and Canadian, U.S. and international stocks. Since 1979, the benchmark return for a portfolio similar to their current asset allocation – diversified across the aforementioned asset classes – has averaged about 8-per-cent annual returns.

3. Interest rate hikes are not entirely bad for their portfolio.

Rising interest rates can result in capital losses to their fixed-income assets in the short-term, but at the same time, rate hikes generally only occur in the midst of good economic conditions. As a result, their equity holdings will likely increase in value as the economy improves, which should offset any losses sustained to their bond holdings. Longer-term, rising rates are good news for retirees reliant on fixed-income investments because despite the initial losses to bond holdings, future investment in this asset class will provide higher yields based on higher interest rates.