Sam and Martha are 55 years old. They have two children in their late twenties. The only money that they have ever borrowed is to invest in real estate. They are frugal and fairly risk averse.
Sam is a management consultant. His income varies between $70,000 and $100,000 a year before taxes. Martha works for a non-profit organization, earning $37,000 a year. Her employer provides good dental and extended health benefits. Neither have a pension.
They recently moved into a home worth $500,000. Their mortgage is $165,000, with biweekly payments of $528. They spend about $53,000 a year on their lifestyle.
They plan to retire at age 65, but they would consider doing that sooner if they can be confident of generating sufficient income during their retirement years, which they define as $60,000 per year in today's dollars until age 95.
Their main investments are in real estate. They own two detached houses located elsewhere in B.C., with no mortgages. One could probably be sold for about $200,000 for a gain of $60,000. The market value of the second property is $400,000, which is up about $20,000. They are renting these properties out, but with taxes, property management fees, repairs and maintenance, currently they are just breaking even on these properties each year.
Sam has $120,000 in his RRSP, which he trades on-line. It is split between common stocks and exchange traded funds. Most of these assets are socially screened, and split between Canadian and US equities. The RRSP was once worth $165,000, and it bothers him that his investments are still down. He also has $16,600 in a fixed income RRSP yielding 3.5 percent.
Martha has $112,000 in her own RRSP, with $63,000 in fixed income and $49,000 in equities. Most of her RRSP is in exchange traded funds and some 'green' mutual funds. She also has a spousal RRSP worth $38,500 which is mostly invested in a pooled mortgage fund.
Their only non-registered financial asset is a cashable certificate for $19,000 at 1.5 percent interest. This money is set aside to cover anticipated repairs to their new house.
From 1985 to 1995 Sam and Martha used an advisor and invested in mutual funds, which gave them an average return of less than 2 percent per year. Since then, they've being "doing it themselves." They are open to other options except investing in mutual funds.
Both of their parents helped them get started financially. They would like to carry on this legacy by leaving their children an estate, and are also open to considering ways to transfer wealth to their children prior to their demise.
Sam and Martha have a number of questions, but their main one is whether the retirement income goal of $60,000 in today's dollars achievable? If so, could it be higher?
Fortunately for Sam and Martha, even using conservative assumptions, the objective of retiring at the age of 65 is achievable. They probably could retire even a little ahead of schedule. They will need some repositioning of their assets to do this though.
If we assume inflation runs at 3 percent they can retire at age 61. With 4 percent inflation they can retire at 64. This is assuming that their current assets are working efficiently for them, but with no further contributions required. Any extra contributions just makes the scenarios that much more attractive.
As to whether a higher income is possible, certainly it could be higher, but there would be probably be some tradeoffs with some of their other objectives. Are they willing to work longer in return for that higher retirement income? Are they willing to reduce their commitment to providing their children a head start in life? It's all a matter of priorities.
But there are some interesting inconsistencies here. Sam and Martha describe themselves as fairly risk averse, yet 88 percent of Sam's assets are in ETFs and stocks that he trades online, which has led to a 28 percent decline in the equity portfolio. There is also a lack of diversification here. 68 percent of their assets are in real estate, only 19 percent in equities and just 11 percent in fixed income.
For me the most interesting sentence in this case study is "They are open to other options except investing in mutual funds." Why is that?
Is it because they are looking to avoid a repeat of poor performance? If so, why would they single out mutual funds? Their real estate investing hasn't been phenomenal, and their "green" investments and exchange traded funds weren't able to dodge the Great Recession either.
To dismiss mutual funds is something that I don't understand. It would be like having a bad experience with a car once, and then want to talk about transportation options but excluding all cars from the conversation.
I am also puzzled by their investment experience between 1985 and 1995. That was actually was a great decade for investment returns. Even cash had an annual average return of 8.9 percent, while GIC's yielded 9 percent, Canadian equities made 9.7 percent, Canadian bonds returned 9 percent, high yield bonds came in at 12.7 percent, European and Far East equities both ran about 15.5 percent and U.S. equities topped the list at 16.6 percent. So, despite virtually all investment classes pulling strong performance, Sam and Martha's individual performance was meagre.
I suspect that the reason for their poor returns may lie not in the products, but in either Sam and Martha, the advisor of the day, or both. In other words, it wasn't the investments themselves, but rather the investor behaviour that caused the problems - by falling into the age-old trap of buying high and selling low, and repeating the cycle.
Investor behaviour is almost always the reason behind an investor's individual performance coming in at 2 percent in a decade where even conservative investments yielded 9 percent. If that's the case, the same thing is likely to happen in the future unless the clients understand what happened and change their strategy to one of buying quality investments at good prices and holding them for the long-term.
The opinions expressed are those of Brad Brain, CFP, R.F.P. CLU, CH.F.C., FCSI. Brad Brain is a Certified Financial Planner with Manulife Securities Incorporated, Member CIPF and with Manulife Securities Insurance Agency in Fort St John, BC. Brad Brain can be reached at email@example.com or www.bradbrainfinancial.com.