Retirement planning: How to fix a money-losing portfolio | Family ...

Situation: Despite sound savings history, investment returns have been low

Strategy: Sell high-fee, high-risk assets, buy shares that pay dividends

Solution: Retirement income sufficient to maintain lifestyle

In the business of managing communication networks, an Albertan we?ll call Edgar has been successful. He brings home $9,500 a month after tax. He worries about his retirement, even though he is far from a spendthrift. Edgar, divorced and his two children grown, saves almost $5,500 of his salary every month and has no expensive entertainment or hobbies sucking up his money.

The problem is that the $1.2-million in net financial and real estate assets he has accumulated is not giving him the return he would like to allow him to retire in two years when he turns 65. He is frustrated with low returns from his portfolio of high-fee mutual funds and unsuccessful bets on small-cap funds and resource plays.

My returns from my portfolio are disappointing. My dividends from the large caps are eaten up by management fees in the mutual funds.

?I have lost money in my small-cap resource stocks,? he says. ?My returns from my portfolio are disappointing. My dividends from the large caps are eaten up by management fees in the mutual funds. I am at a loss as to what to do in order to ensure that I have enough money to retire.?

He is already looking toward a little more luxury in the fairly modest life he has led to date. He would like one day to trade his 2008 Toyota Corolla for a mid-level Mercedes Benz.

In retirement, Edgar hopes to travel in Asia, where he can set down his easel and paint landscapes of rice paddies and mountains. The problem, however, is that his investments may not support such a lifestyle.

Family Finance asked Benoit Poliquin, a financial planner, portfolio manager and chartered financial analyst who heads Exponent Investment Management in Ottawa, to work with Edgar.

?The past 10 years have been the most disappointing period since the Great Depression. But we can do a lot to improve Edgar?s returns,? the planner says. ?His strength lies in his frugal ways. His risk is in the portfolio.?

Investment management

Edgar?s real estate holdings create complexity. He has a $131,000 mortgage on his $340,000 house and has just put $40,000 down on a new $400,000 investment condo to be built in a couple of years. Mr. Poliquin suggests Edgar?s best bet is to use his $500,000 in cash to discharge the present mortgage and the future debt when it becomes payable. His financial assets will shrink to $845,000 after he pays off the mortgages, but he should be able to clear $1,000 a month, or $12,000 a year, in rent from the condo. That will help form part of his future retirement income.

Edgar blames high management fees that eat up dividends from large-cap stocks in his blue-chip funds, picked with counsel from his roster of six advisors. He has large losses from his exposure to resource-sector flow-through shares, which pass tax benefits from exploration to the investors. High packaging fees tacked on by promoters drain returns. The result is money-losing investments.

There is an obvious need to restructure the portfolio to reduce risks. Edgar should sell volatile resource stocks and reallocate money to dividend-paying stocks and exchange-traded funds with shares that grow their dividends, the planner says.

He can also add a corporate bond ETF. He could expect 4% in dividends or bond income plus growth of capital from his $845,000 in financial assets remaining after paying off all debts.

The annual returns would be $33,800 before tax. He can also cut his management fees, which are up to $32,500 a year on his mutual funds. By using a fee-only advisor who would charge perhaps 1% a year, Edgar would cut management costs to $8,450.

Edgar is saving $64,560 a year in cash, RRSPs and his TFSA. In two years to retirement, he can add $129,000 to savings. That would push his financial assets to $974,000. At a 3% real return, this would produce pre-tax income of $29,200 before tax and a small charge for professional management of the funds saved in the past two years, should he choose to include the added funds in the managed pool.

Retirement plans

When Edgar retires at 65, he will get CPP of $11,740 and OAS of $6,540.? That plus rental income and investment income will give him $4,200 to spend each month after he pays 15% average income tax. That is more than enough to cover present expenses because he will not have to make mortgage payments and won?t have to save any more money for his retirement.

If he chooses to exhaust his capital by age 90 and his annual return after expenses is 3.0%, his annual investment income, including returns from two more years of savings, would rise to $59,640. Adding in rental income, OAS and CPP, he would have total annual pre-tax income of about $90,000 and monthly after-tax income of approximately $6,400.

He needs to cut costs and stabilize his investment income. If he does that that, he will be on track for a secure retirement

But Edgar would be vulnerable to the OAS clawback that takes 15% of income over $69,562 a year. The clawback would cost him $3,100 annually, or about $260 a month, leaving net after-tax monthly income at $6,140.

This is the income he will have without the Mercedes. If he chooses to spend some of surplus, perhaps two years? worth of cash savings that amount to $52,560 a year, he will have less investment capital and income in retirement. Even if he does trade up, he will have ample income to continue his present way of life.

?Edgar has been a diligent saver but not a proficient investor,? Mr. Poliquin says. ?He needs to cut costs and stabilize his investment income. If he does that that, he will be on track for a secure retirement.?

Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis.

Source: http://business.financialpost.com/2012/11/09/family-finance-big-savings-small-returns/

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