At 56, Angela is on her own again and not working. Her children are gainfully employed and no longer living at home. “I have no income other than the returns on my investments,” Angela writes in an e-mail. She has a home that is fully paid, a tax-free savings account, a registered retirement savings plan and a non-registered investment account.
“My main concerns are knowing how much I can spend on a monthly basis, and my asset mix,” Angela writes. “I have a high tolerance for risk so all my investments are in equities except for a cash balance which I keep in a high-interest savings account,” she adds. She would like an opinion on how many months or years worth of expenses she should keep in the bank account.
“I am trying to maximize my returns because of how early I retired, and I’m compensating for how aggressive my portfolio is by keeping two years of expenses in cash so that if there is a market downturn, I don’t have to draw on my investments.”
She is living on about $4,000 a month after tax and wonders whether she can “safely budget $4,500.”
We asked Michael Cherney, an independent Toronto-based financial planner, to look at Angela’s situation.
What the expert says
Angela wonders whether her current assets, together with her Canada Pension Plan and Old Age Security benefits in time, will be enough to allow her to remain retired, Mr. Cherney says.
Angela’s investment strategy – shunning bonds and keeping nearly $90,000 in a savings account – is risky in some ways, the planner says. Being 100-per-cent invested in stocks “gets you higher returns over most, but not all, time periods,” he says. “But it also exposes you to higher risk.” In the 2008-09 financial crisis, for example, an all-stock investor would have been down about 50 per cent at one point, compared with a drop of about 30 per cent for a balanced portfolio of stocks and bonds, he adds. And financial markets don’t always bounce back as quickly as they did then.
“In other ways, it is too safe because she has a large float of cash – arguably too large,” Mr. Cherney says.
Angela is also concerned about how to withdraw from her various accounts. In 2008, she withdrew $40,000 from her RRSP. “This year it has been all from her non-registered account,” the planner notes.
“My first advice to her is to reduce the amount of cash that she has,” Mr. Cherney says. She holds cash because she wants to be able to withstand stock market downturns, and there is some validity to this, the planner says. She’s trying to avoid sequence of return risk, which refers to what happens if the markets are down in your early retirement years and you are making regular withdrawals.
“Angela is just replacing one risk with another, namely having too much cash.” He suggests she reduce her cash holdings and introduce a bond component to better diversify her portfolio.
As well, Mr. Cherney suggests Angela rejig her investments by switching some of her Canadian stock holdings to U.S. and global stocks for better balance and diversification. She might be able to lower her investment costs by using exchange-traded funds.
As to which account to draw from first, “the overriding principle is to provide a consistent, indexed retirement income, maximizing after-tax income,” the planner says. Angela should be able to withdraw enough from her portfolio to give her $4,000 a month after tax and still keep her income tax within the lowest bracket (20.05 per cent combined federal and Ontario income tax for income up to $43,906 a year), he says. To keep things simple, the planner recommends the following:
First, she converts her RRSP to a registered retirement income fund (RRIF), and then draws from it, her TFSA and her non-registered investment account “in a balanced way." This will provide a combination of fully taxable (RRIF), preferentially taxable (dividends and capital gains from her non-registered investment account), and non-taxable income, both from her TFSA and the return of capital from her non-registered account, Mr. Cherney says.
Each January, she should take enough money from her non-registered account to contribute the maximum to her TFSA, he says.
Regarding CPP and OAS benefits, the planner suggests Angela wait until she is 70 to begin taking them. That would increase her CPP entitlement by 42 per cent and OAS by 36 per cent. It would give her higher guaranteed and indexed income starting at 70 and protect her more “in the happy event that she lives a long life,” the planner says.
The planner’s forecast assumes Angela lives to age 95, earns an average rate of return of 4.5 per cent on her investments and that inflation averages 2.5 per cent a year. It also assumes she continues to live in her existing condo and spends no more than $4,085 a month.
What would happen if Angela increased her spending to $4,500 a month? Using the same assumptions, she would run out of savings at age 89, at which point she could sell her condo, invest the proceeds and rent an apartment, Mr. Cherney says, although she may prefer to do that a few years earlier.
The person: Angela, 56
The problem: Determining how much she can spend each month and whether she has the right asset mix.
The plan: Rejig her portfolio to add some bonds and better diversify her stock holdings. Draw from taxable and non-taxable accounts evenly, defer CPP and OAS to age 70.
The payoff: Financial security
Monthly net income: $4,000
Assets: Cash in bank $88,600; stock portfolio $460,000; TFSA $79,000; RRSP $455,000; residence $600,000. Total: $1.68-million
Monthly outlays: Condo fees and property tax $585; home insurance $30; utilities $210; maintenance $30; transportation $355; groceries $600; clothing $150; gifts, charity $265; vacation, travel $420; dining, drinks, entertainment $400; personal care $175; club membership $50; sports, hobbies $100; subscriptions $20; other personal $135; health care $300; phones, TV, internet $175. Total: $4,000
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