Knowing your lifestyle wants will lead to appropriate asset allocation decisions, experts say
Experts say you should start with lifestyle planning first, followed by financial planning and then investments. Photo by Getty Images/iStockphoto files By Julie Cazzin with Allan Norman
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Q: I’m 71 and collecting Canada Pension Plan (CPP), Old Age Security (OAS) and Guaranteed Income Supplement (GIS). My husband Dave is 61 and collecting a CPP disability pension that will be replaced by regular CPP at age 65. The payments will then likely only be a very low $1,800 per year. I have $550,000 in a registered retirement savings plan (RRSP) as well as $40,000 in a tax-free savings account (TFSA), while Dave has $70,000 in an RRSP and $40,000 in a TFSA. Together, we own our townhouse in Calgary and are mortgage free.
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I moved all my RRSP investments into a money market account at an online brokerage account five years ago because I was apprehensive about a market crash, and I seem to need some help getting back into the market. I’d like to invest in a basic index portfolio of 60-per-cent equities and 40-per-cent bond exchange-traded funds (ETFs) and withdraw four per cent a year as many experts advise. Does this sound like a good, conservative investment plan to you? — Monica
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FP Answers: Monica, in your quest to save some money by investing through an online broker, I fear you may have lost something even more valuable: time. That’s time you and Dave could have been doing more things you enjoy, but didn’t. Now, time has zipped by, just like the next five years will zip by if you don’t do something about it today. I’m going to help you understand the truth about your money and what’s possible for you and Dave in the time you have left with your current and future resources.
Once you know what is possible, you can start thinking about and identifying the lifestyle you really want. Then you can take that knowledge and use it to answer your questions about the passive portfolio, the proper allocation and the four-per-cent withdrawal rule, which, to me, doesn’t make sense. It’s a rationale used to avoid doing the hard work of proper lifestyle planning.
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I sense you’re very good at managing your money and stretching a dollar, but at what cost to your lifestyle? It’s time to discover the truth about your money and to do that I am going to make a few assumptions. Your home value is $500,000 and appreciating at three per cent annually, investment growth is five per cent and inflation will return to two per cent. We’ll also assume you both live to age 90 and would like to enhance your lifestyle.
You have $700,000 in investments, a home and you’re living on about $40,000 per year before tax. What is your reason for not spending more? What are you waiting for? Are you waiting until you are 81?
Next year, registered retirement income fund (RRIF) minimum withdrawals will start and that will also be the last year you’ll receive the GIS. Your annual pre-tax income will go from $40,000 to about $65,000 and remain there until Dave passes 10 years after you, at age 90.
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Deciding to reinvest that extra income, while maintaining your current lifestyle, means leaving someone about $3.2 million when you both pass. Is that your intention? Enhancing your lifestyle and spending the additional RRIF income means leaving someone $1.8 million when you both pass.
It is up to you, Monica. How do you want to use your money? Are there additional things you and Dave want to do while you are able and in the time you have left?
Recommended from Editorial FP Answers: Will the Canadian dollar go up in value? FP Answers: Pros and cons of fixed vs variable mortgages as borrowing rates rise FP Answers: My portfolio is down 30%. Do I still have enough to retire this year? Using this approach to formulate a withdrawal strategy, you’ll squeeze more out of life than by simply applying the four-per-cent withdrawal rule, but it takes more work. You have to be willing to discover the truth about your money and you should monitor your glide path annually.
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Article content Knowing your lifestyle wants will lead to appropriate asset allocation decisions. The 60/40 portfolio split is more about managing volatility rather than income. For example, the need for $30,000 in annual income may mean only holding $100,000 of cash and bonds in your portfolio, or 15 per cent of your total portfolio. With this allocation, if markets crash, you have a three-year recovery window and a relatively safe place to draw your income for three years.
Make your first allocation decision based on your annual income needs, then consider your comfort with market volatility. The more discomfort you have with volatility, the more bonds or even alternative investments you may want to add.
As for that push into the markets, statistically, you’re best to invest all your money into the equity markets today, but I know that’s not always easy to do. Consider investing your money over the course of the year on a monthly basis. If markets drop, increase the size of your investment.
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Article content It’s odd, but many people, including financial advisers, start with investments first and work backward to financial planning. If you start with lifestyle planning first, followed by financial planning and then investments, everything will make much more sense and you’ll be able to make quick and easy decisions with confidence.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. Allan is also registered as an investment advisor with Aligned Capital Partners Inc., a member of IIROC, He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca. This commentary is provided as a general source of information and is not intended to be personalized investment advice.
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