Client profile

Brad and Lydia Anderson* are both 60 years old. Brad is a successful IT consultant, and Lydia is a senior manager at a construction equipment manufacturer. They have no children.

When previously profiled in an earlier instalment, they were both 50. They’d planned to retire at 65 and wanted to purchase a vacation property. Our experts recommended they use a goals-based approach to create three portfolios, each with a different risk and expected return, for:

  1. retirement,
  2. property acquisition and
  3. discretionary spending.

Now, 10 years later, Brad has been winding down his IT consultancy. He has decided to sell the residuals and focus on his health after suffering a heart attack. He’d like the sale proceeds, which he expects to be about $50,000, to go to the hospital where he received heart treatment.

If possible, Lydia would like to retire, too, so she and Brad can spend more time together (neither client has a pension). They’d like a post-retirement income of $150,000 per year — $125,000 for necessities and $25,000 for discretionary spending.

Is that possible if they both retire now?

*This is a hypothetical scenario. Any resemblance to real persons is coincidental.

The situation

Previously, under their plan at age 50, the goals-based approach successfully allowed Brad and Lydia to purchase a cottage. With that account spent, now only the retirement and discretionary spending portfolios remain.

The expert

Sam Sivarajan

Sam Sivarajan

senior vice-president of wealth, individual customer, at Great-West Life, Toronto; previously head of Manulife Private Wealth, Toronto

The retirement portfolio was 70% equity, reflecting the extended time horizon originally established for retirement (15 years). The discretionary portfolio had a 60% equity allocation, which covered its short, medium and long terms.

Sam Sivarajan, senior vice-president of wealth, individual customer, at Great-West Life in Toronto, and previously head of Manulife Private Wealth in Toronto, estimates that annualized returns in the last decade for the couple’s retirement and spending portfolios were 7.50% and 6.00%, respectively, net of fees and taxes.

“We project [returns] at the asset class level,” says Sivarajan, and managers potentially over-deliver. These updated annualized returns are based on results of 7.89% (net of fees but not taxes) for a 60/40 portfolio he managed in 2016.

This puts the current portfolio sizes at about $2.5 million and $450,000, respectively.

The solution

The goal now is to invest so that Brad and Lydia can decumulate to fund retirement, says Sivarajan. The new goal, as well as changes in market expectations, requires a revised investment strategy and asset allocation.

Projected returns are lower for the two portfolios, at 4.7% and 4.3%, respectively — again, at the asset class level (see “Goals-based investing,” below). “We’re in a low-yield environment; we’re nine years into a bull market,” says Sivarajan. “We’re being prudent.” Allocations in the spending portfolio are slightly more conservative because the portfolio covers a shorter term. To help offset low returns, Sivarajan adds two assets classes the couple didn’t have before: global REITs and global infrastructure.

He also takes a portion from the retirement account to create a new portfolio: non-discretionary ($500,000). Again, to offset lower returns, Sivarajan suggests the new portfolio be fully and directly invested in real assets, like commercial real estate and agriculture.

Real returns are “not correlated to the stock market or interest rates,” he says, making them less volatile. Plus, they’re a hedge against inflation and they pay income. The expected return is 5.5% gross, based on CPI + 4%.

Investing in real assets is at least a five- to seven-year commitment, explains Sivarajan, and only for accredited investors who meet suitability requirements. “Suitability involves a number of factors including the investor’s emotional comfort as well as financial ability to deal with the lack of liquidity associated with these types of investments,” he says. Real estate, for example, can’t be bought and sold on a daily basis, like stocks and bonds, so investors must be ready — emotionally and financially — to hold private assets for several years before contemplating an exit.

“If you needed [the money] next year or in two years, you wouldn’t do this,” he adds, noting that some portfolios allow a one-year lock-in. “The one-year notice period is simply to accommodate the unforeseen,” he explains. Withdrawal after a short period “is not viable given the private nature of these assets.”

Brad and Lydia have other sufficient liquid assets and can make this investment commitment.

Accounting for 1.5% inflation, Sivarajan calculates the couple has sufficient retirement income to age 90 based on allowing the real assets to grow for 16 years and then transferring them back to the original retirement portfolio for the last 14 years. The transfer results in no tax implications because Sivarajan assumes that taxes and fees have been paid annually (25% of the portfolio’s annual income).

“That injection allows Brad and Lydia to fund $125,000 a year plus inflation for essentials like food and rent,” he says. And the spending portfolio of $25,000 a year plus inflation, for luxuries like vacations, lasts for 25 years, to age 85, when the couple is probably travelling less and spending less.

If Brad and Lydia think they’ll live beyond age 90, or if they encounter a large, unexpected expense (e.g., long-term care), they could cut back or eliminate discretionary spending. They also have the option of selling their vacation property. The plan should be revisited — and revised now or at a future point — if conditions merit it. “This may mean changing retirement spending plans, [a] slightly different investment strategy [or] a combination of the two,” says Sivarajan.

Every year, the portfolio should be reviewed and adapted to market conditions and other potential changes, like tax laws, adds Sivarajan (note this is a simplified projection that doesn’t factor such things as tax efficiency, income splitting, additional RRSP contributions, CPP/OAS or the sale of the cottage).

Goal based investing portfolio with asset class and expected return

Degree of difficulty: 2 out of 10

Sivarajan builds on the previous portfolios established for Brad and Lydia, and he presents numbers that clearly show they can retire comfortably now. The plan is easy to accept, but: “It’s not once and done,” he says. “We need to look at what we can expect in the market going forward and what are some of the new tools we have to deal with it.” Though he says the plan will be revisited annually, reviews could be more frequent “if there are material changes in the couple’s financial or personal circumstances or there are dramatic changes in the market.”

Client acceptance: 10 out of 10

Already sold on goals-based investing, Brad and Lydia are pleased to continue with the approach, especially when the numbers show they can fund their desired lifestyle. They accept that they may have to potentially forgo luxuries at some point. They also easily embrace investing in real assets because Sivarajan explains that the approach is used by institutional investors and offers alternative risk exposure. They appreciate the concept of insulating part of their portfolio from the market, because they’ve experienced downturns, including the financial crisis, the tech bubble and Black Monday.