Toss the Exotic Funds and Rebalance


In Vancouver, a professional couple we'll call Gerald and Hannah, 58 and 56, respectively, have successful careers, a combined net monthly income of $9,420, a house they think they could sell for $900,000 and various investments that recently totaled $689,000.

Their portfolio has been injured in the present bear market, but it should eventually recover. However, they have an enduring problem with above-average fees and exotic mutual funds. They see their problem as one of poor returns.

"Our investments have delivered only 3 per cent per year over the last five years," Hannah explains. "What do we do now?"

What our expert says

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple. His analysis is straightforward.

"The root of the problem of poor returns is excessive risk and that comes from lack of diversification," the planner says. "They have 30 equity funds bought almost entirely from the same company. The funds are in some cases duplicated in their cash and registered accounts."

Their fund holdings include health sciences, global science and technology, Japan and the Pacific rim, biotechnology, financial services, consumer products, emerging markets and European equities.

"The characteristic of each of these sector funds is a higher management fee than would be charged for a broad market equity fund," Mr. Moran says. "There is no fixed-income exposure, not even a balanced fund with some bonds. What shows is that these folks, who are not sophisticated investors, have been led on a fund shopping spree with high costs and without corresponding benefits."

Gerald and Hannah have the time and resources to fix their portfolio. They need to move away from 100 per cent equity exposure, Mr. Moran says, by paring their equity funds and adding bonds. Government bonds are yielding very little, but corporate bonds pay handsomely. Investing in corporate bonds, which may have complex credit issues and provisions that allow issuers to call them back, should be handled by a professional manager, he adds.

Neither Gerald nor Hannah are in a rush to retire. Over the next few years, they should build up bond assets. It is conventional to say that one should hold bonds in a percentage equal to age, but that is relatively crude. If balanced funds, which usually hold bonds, are added to the portfolio and if some of the more exotic sector funds, such as global biotech, are dropped, then the bond-to-stock ratio could be adjusted to balance equity risks.

A financial adviser could be hired for perhaps 1 per cent of assets under management. That fee would be less than half of what their cocktail of sector funds now charges for annual management, Mr. Moran says.

Assuming that they retire when Gerald reaches age 65 in seven years, then he will have earned 93 per cent of maximum Canada Pension Plan benefits, currently $10,905, and Hannah will have earned 88 per cent of maximum credits. Each will qualify for full Old Age Security benefits, currently $6,204 a year. If Hannah begins receiving CPP benefits at 63, when Gerald is 65, she will be penalized at a rate of 0.5 per cent per month for each month prior to age 65 at which she begins the benefits. She will therefore receive $9,596 after adjusting for her entitlement and age, the planner notes.

If Gerald and Hannah continue to save $3,000 a month and assuming an annual 3-per-cent real rate of return on their present asset base of $689,000 of registered and unregistered assets, then they would have savings of $1,131,507 when Gerald is 65.

If each partner lives to age 90, their savings would support an average annual taxable income of $58,945. Added to their CPP income and OAS benefits, they should have about $85,650 for the first two years of retirement after Gerald is 65 and then $91,854 a year once Hannah's OAS benefits begin, the planner estimates.

Once fully retired, the couple will have more to spend each year than they do now, for many savings and work-related expenses will be eliminated, Mr. Moran says.

Gerald and Hannah have life insurance but do not really need it, Mr. Moran says. If either partner died today, the survivor would retire with full CPP for one person, one OAS cheque, and most of the income from their investment portfolio.

"This couple have an asset management problem rather than a money problem," the planner says. "If they can restructure their portfolio to add fixed income, reduce fees and cut risk, they should have a very comfortable retirement."

Client situation

The People

Couple, 56 and 58, with no kids.

The Problem

Low returns in a risky investment portfolio loaded with 30 equity funds.

The Plan

Pare the equity funds, add bonds, cut fees.

The Payoff

Potentially higher and more stable returns.

Net monthly income



House $900,000; RRSPs $689,000; taxable investments $56,000; Total: $1,645,000

Monthly expenses

Property taxes $200; food & rest. $725; entertainment $250; clothing $300; grooming $100; RRSPs $3,000; car fuel, repairs $190; travel $670; car, home insurance $250; life insurance $38; utilities & phones $255; charity and gifts $342; misc. $400; savings $2,700; Total: $9,420

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