Globe and Mail: Early Retirees Need To Overhaul A 'Way Too Aggressive' Portfolio

April 8, 2016

When they took early retirement last year, John and Janice left their home in Edmonton and moved to B.C.'s Sunshine Coast. Now they're wondering if they left the working world too soon.

"We decided to anticipate our retirement, and we are panicking now that we did it too soon, too fast," John writes in an e-mail. He is 62; she is 58 and an American citizen.

"My income is about $1,000 a month between a disability pension I get from the federal government and a small pension from a short time I was employed with the federal government," John writes.

When he turns 65, his disability pension will be replaced by full Canada Pension Plan benefits.

While his work pension is small, it includes a comprehensive health and dental plan for both of them, and "that represents a great help in our budget," John adds.

Janice worked in IT but lost her job because of the oil price collapse. She, too, has a small work pension.

"In Alberta, we were living comfortably on my wife's income, my small pensions and the income from a rental property we had," John writes.

They sold the rental property but kept their home in Edmonton, which they are renting out at a break-even rate but hope to lease profitably in a couple of months.

"Are we drowning?" he asks.

We asked Jason Pereira, a financial planner at Woodgate Financial Inc. in Toronto, to look at John and Janice's situation.

What the expert says

John and Janice "are nowhere near drowning," Mr. Pereira says. They are nervous because they are having to draw heavily on their investments during a time of stock-market turbulence. Their financial pressures will ease when they begin collecting government benefits.

To start with, Mr. Pereira has John and Janice selling all of their financial holdings and reinvesting the proceeds.

"This portfolio is way too aggressive," he says. They have a disproportionate amount of equity holdings, especially technology and growth companies, and even a private-placement second mortgage. "There are little to no dividend payers and nowhere near enough bonds."

The planner's questionnaire revealed the couple as "average risk, balanced investors," implying a portfolio of 60 per cent stocks and 40 per cent bonds, Mr. Pereira says. The balance would shift to 60 per cent bonds and 40 per cent stocks at age 65, which should give them a long-term rate of return of 6.6 per cent, he says.

"The only way this will work is if they seek out professional investment advice," the planner says. "They need help designing and managing a balanced, diversified portfolio that suits their goals."

Because Janice is an American citizen, there will be instances when the couple need to seek expert advice on cross-border taxation before investing or shifting assets, Mr. Pereira says. Janice has to file a U.S. tax return each year. She was behind but is catching up. She cannot take advantage of a tax-free savings account. As well, only the first $250,000 of her share of the sale of any principal residence is tax-free.

Selling off their holdings will result in some capital gains for the current year, which will help cover their substantial shortfall. John and Janice should set up an emergency fund of at least $28,000 in cash, Mr. Pereira says. John should continue contributing to his tax-free savings account "for the rest of his life."

In the next few years, Janice will begin collecting CPP and U.S. Social Security benefits, and both will get reduced Old Age Security benefits at age 65. (They have not been in Canada long enough to get full OAS.) "These, along with their pensions, will cover most of their expenses."

In 2017, they should both start taking funds from their RRSP/RRIF (registered retirement income fund) to take advantage of their low tax brackets, the planner says. Janice should apply for CPP at age 60 and U.S. Social Security at 62, the earliest possible date.

If all goes well, they will have amassed a substantial estate by the time they are 95 (their assumed lifespan). "The plan is very safe," Mr. Pereira says. "Assuming a 3 per cent rate of inflation, the plan only needs a 3.75 per cent rate of return to succeed. That is less than a one-percentage-point real rate of return." They could spend more if they wanted to, he acknowledges, "but they need to maintain a cushion in case their health turns."


Client situation

The people: John, 62, and Janice, 58.

The problem: Did they make a big mistake when they retired early last year?

The plan: Sell their risky investments and get help setting up a properly designed investment portfolio that suits their needs and risk tolerance.

The payoff: Peace of mind.

Monthly net income (current): $1,400

Assets (in Canadian dollars): Non-registered investments $278,299; RRSPs $91,935; his TFSA $44,064; her locked-in retirement account $51,334; her Roth IRA (a U.S. savings account) $135,103; Edmonton house $480,000; B.C. residence $400,000. Total: $1,480,735

Monthly disbursements: Property tax $280; maintenance and repair $200; other housing $260; transportation $406; grocery store $800; clothing $200; gifts $50; vacation, travel $700; dining, drinks, entertainment $150; grooming $100; club memberships $95; pets $120; sports, hobbies $100; subscriptions $100; other personal $100; doctors, dentists $100; prescriptions $50; health, dental insurance $74; telecom, TV, Internet $280. Total: $4,165

Liabilities: None