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The risks of being conservative

Couple worries having no exposure to stock market poses long-term risk to retirement

Posted: 08/16/2014 1:00 AM | Comments: 0

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PHOTO ILLUSTRATION SARAH TAYLOR / WINNIPEG FREE PRESS Enlarge Image

The retirement finances have gone pretty smoothly for Don and Marie.

They are in their 60s and have a net annual income of more than $52,000, and that seems to cover all their needs.

In fact, their retirement income does more than cover the expenses. The couple have had enough surplus cash flow to save up tens of thousands of dollars in the last few years to fund improvements to their home.

With no debts, and even the ability to take a big vacation worth $5,000 once every two years, the couple should be worry-free, smiling retirees.

Yet they still worry, and their stress largely revolves around the dreaded destroyer of pensioners' wealth: inflation.

Part of their concern stems from their investment preference.

"I'm a very conservative investor," says Marie. "If I do invest, I'd rather have a little return than a chance of losing money."

They certainly have their reasons for being risk averse beyond the fact they're retirees. A past foray into the stock market ended badly.

"Quite a few years ago he (Don) had all his money with (a mutual fund company), and he let them have it for seven years and lost money," she says.

"He never went back to mutual funds again."

To boot, their adviser at the time was pushing them to borrow against their home to double down on the stock market.

They never did, and ever since, the couple have largely stuck with GICs and savings accounts for their approximately $340,000 in savings. And just to add another layer of safety, their money is spread out across a number of financial institutions.

"I think we have too much stuff in too many different things," Marie says. "I can keep track of them but I'm wondering if we could get a better bang for our buck if we go with one institution?"

While the couple feel their assets are meeting their needs, they still have a nagging sense that maybe they should be doing more--and that perhaps 'doing more' means taking on additional risk in their portfolio.

"Maybe we shouldn't or maybe we should?" she says.

Carlos Machado, a portfolio manager at CIBC Wood Gundy in Winnipeg, says Don and Marie are in good shape as is so they shouldn't take on more risk with their money, particularly if they're not comfortable doing so.

"If by maintaining a very conservative investment approach, you can cover all of your expenses and maintain the lifestyle that you desire at retirement, keep that conservative approach."

Furthermore, he commends the couple for having dodged the bullet of borrowing against their home to invest a few years ago.

Although Don had a difficult experience investing in mutual funds where he lost money over a seven-year span, the casualties to his dollars would have been much worse had he borrowed additional cash to invest, Machado says.

"Not only would he have lost money, he would have had to pay back the borrowed money that was lost," he says. "That's why we feel that borrowing to invest should only be done by very sophisticated investors who are comfortable with the risks associated with this strategy."

And certainly, Don and Marie do not fit this profile.

Yet despite being in fairly good financial shape, the couple can take a few steps to improve their financial situation.

One recommendation is splitting Marie's pension income. At the moment Don is withdrawing $1,200 a year from a RRIF even though he has about five years before he needs to, so as an alternative, they could elect to stop those withdrawals, and have Marie transfer $2,000 of her pension per year to Don.

"This would not save them very much, but it is more tax efficient as Marie is in a higher tax bracket than Don."

And every little bit helps if their goal is to preserve their wealth going forward with a conservative investment strategy that keeps pace with inflation. At the moment, inflation isn't a concern at about two per cent or less, so if Don and Marie can earn, two per cent, they're breaking even.

This is likely good enough since they're not spending more than they earn. Still, Machado says they should reconsider having substantial amounts of money sitting in savings accounts. Instead, that money should be invested in GICs -- preferably using laddered strategy where they have some money coming due every year that can be either spent as required or reinvested.

But this type of strategy requires making every dollar count and that means making full use of their TFSAs.

"It seems as though they have not made this year's TFSA contribution," he says. "If not, they should do that ASAP -- especially with the majority of their investments being interest bearing (which are taxable as regular income); they want to shelter as much of that from tax as possible."

Machado says these steps should help keep them ahead of inflation, eliminating the need to take on more risky investments.

"Most investors would do well to keep the following in mind: An increase of five to 10 per cent to their overall wealth probably won't cause them to change their standard of living, but by taking on more risk, if they lost 10 to 40 per cent or more as many investors did in 2008, that would surely cause them to lower their standard of living."

With regard to Don and Marie, they're maintaining their standard of living and even accumulating wealth, so they're on the right track.

Still, they should consider future risks other than inflation. The big sore spot, in Machado's view, is the potential future costs of long-term care.

"This is an area that many people overlook when planning for retirement," he says. "People will generally look at their current expenses, income, current lifestyle needs and savings and determine whether or not they will be OK."

What many people often fail to do is ask themselves the question: "What would happen if we needed someone to take care of us full time?"

For this reason, Don and Marie should consider purchasing long-term care insurance, which would help cover the costs should one or both of them need to be placed in a long-term care facility. The premiums for this coverage aren't cheap, but neither is this type of care.

"For example, if they were to go into a government-run facility, it would cost them $1,200-$2,400 per month each, and a private care facility can run anywhere from $7,000 and higher per month per person,"

he says.

While the cost of insurance is expensive at this stage of their lives, it's worth considering if they do not already have coverage since they have the free cash flow to afford the cost of the premiums.

Lastly, the couple should consider moving most of their assets with one or two financial institutions.

"By keeping investments at so many firms, none of the advisers has their full financial picture and each one is working in isolation rather than working on an overall portfolio," he says.

This would hopefully improve the level of advice they receive so they wouldn't be advised they need to take on more risk and borrow to invest.

Machado says what Don and Marie need is advice to help them optimize their conservative strategy that preserves their wealth by keeping pace with inflation while addressing their needs and maybe leaving something behind for their loved ones if they so choose.

"If they can do that, they should be in fantastic shape moving forward."

 

Correction to Aug. 9 Money Makeover: The net worth of Gilbert and Nina should have read $596,528 and not $789,189; many thanks to Irene Craig for pointing out the discrepancy.

 

Republished from the Winnipeg Free Press print edition August 16, 2014 B13

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