Renovate your portfolio

Just like a new kitchen, an investment portfolio takes careful planning. And while the building materials may be similar—low-cost exchange-traded funds, or ETFs, are often the best choice—each portfolio needs to be tailored for your temperament and your financial goal. How well do you tolerate stock market turmoil? How long before you need the money? Do you have a pension or retirement income from other sources? Doing this properly is much harder than simply picking a few cheap ETFs.

With that in mind, we found three Canadian households—a retired couple, a family with three young kids, and a single woman—who were in need of a portfolio makeover. Then we put them in the care of Bender—who is both a Certified Financial Planner and a Chartered Financial Analyst—and Shannon Dalziel, also an investment adviser at PWL Capital. They spent dozens of hours creating a comprehensive financial plan and a robust, long-term portfolio for each of our investors. (Rather than accept a fee, they asked the families to make a donation to a favourite charity.)

Each of our investors was struck by how much they would save in fees—on a mid-six-figure portfolio, a 2% savings can be $1,000 a month—but it’s not just about cost. After all, if you’re doing a renovation, you might be able to buy a top-quality power drill at a deep discount, but that won’t help you drive a nail. In the same way, we hope to show you that building a portfolio is all about finding the right tool for the job.

Making It Last: Gord and June Kirk

Gord Kirk quit work six years ago, but he hasn’t spent much time relaxing. Last September, at the age of 57, he entered the Grand Columbian Super Triathlon, which included a five-km swim, a 200-km bike ride, and 50-km run. Some 14 hours later he crossed the finish line first in his age group.

Unfortunately, until recently, the Kirks’ investments weren’t in such good shape. The Kirks had built up a considerable nest egg, but most of it was invested in individual stocks and bonds at a brokerage that charged about $20,000 a year in fees and commissions. Moreover, Gord found it hard to know exactly what his holdings were, or how they were performing. “The information wasn’t available online. I would get monthly statements, but my adviser would say, ‘Don’t worry about those, just call and ask me if you want to know anything. You’re doing great.’”

Born in Ontario, Gord moved in 1978 to Calgary, where he met and married June. He took a job in human resources with PanCanadian Petroleum Ltd. (which later became Encana) and spent 17 years there, helping open offices in Kazakhstan, the U.K. and Venezuela. Then he spent three years at Cabre Exploration, where he accumulated some valuable stock options. He later started his own business as a corporate headhunter, specializing in engineers, geologists and geophysicists. Gord wrapped up the business in 2005, and June joined him in retirement the following year, after a long career as a palliative care nurse.

June’s pension is less than $4,000 a year, while all of Gord’s pension savings were long ago converted to a Locked-in RSP (also called a Locked-in Retirement Account, or LIRA). When Bender asked them to check their eligibility for the Canada Pension Plan, they were surprised to learn Gord is eligible for only 63% of the benefit, while June will get 70%. “A lot of people just assume that they will be eligible for 100% of CPP,” Bender says. “But the Kirks don’t have that, so they have to rely more on their investments.”

Gord and June figure they can live on $45,000 to $50,000 of after-tax income, adjusted for inflation annually. Since the couple retired early, they should plan on their portfolio sustaining them for 40 years. Bender’s job was to help them determine the appropriate amount of risk. If they’re too conservative—putting all their money in GICs and bonds—their annual withdrawals may not be able to keep up with inflation. But if they’re too aggressive, a market downturn could dig a hole from which they’ll never emerge.

Indeed, after losing more than 30% during the 2008–09 meltdown, the Kirks understand they have to view their investments more cautiously now that they’re retired. “This portfolio has got to last through all foreseeable downturns in the future, so I’ve become a little less risk-tolerant,” says Gord.

To help find the right asset mix, Bender uses a financial planning tool called a Monte Carlo simulation. He starts with conservative long-term assumptions: 6.5% returns for equities and 3% for bonds. Of course, short-term returns will vary widely, and that makes an enormous difference: for example, a bear market at the beginning of your retirement is far more devastating than one that comes after 20 years. A Monte Carlo simulation runs a thousand possible scenarios to estimate the probability that a portfolio can sustain a certain withdrawal rate throughout retirement.

Bender likes to stress-test several possible asset mixes, with as little as 20% equities to as much as 80%. In this case, he found an even split of 50% stocks and 50% bonds gave the Kirks the best chance of success. “Interestingly,” Bender says, “when we went more risky, we got a lower success rate, and when we went less risky we also got a lower success rate.”

Gord was impressed with the analysis. “I’ve seen Monte Carlo simulations used in the oil and gas industry, but I had never seen anyone use it for asset allocation. The 50-50 portfolio seemed to be the sweet spot in terms of risk-reward trade-off, so I said let’s go there.” For the fixed-income investments, Bender recommended an ETF tracking the whole Canadian bond market, and another that includes only short-term bonds. On the equity side, he suggested half Canadian stocks, including some real estate investment trusts (REITs), and half U.S. and international stocks.

Before assembling his new portfolio—which is spread across RRSPs, Tax-Free Savings Accounts and non-registered accounts—the Kirks had to transfer all the funds from their previous brokerage. In the tax-sheltered accounts, they were able to sell everything without tax consequences, but the couple did incur some capital gains in the taxable accounts. Since their retirement income is relatively low, however, the tax bill was modest.

The Kirks’ former brokerage charged him $135 plus GST for each of the eight accounts he closed, for a total of $1,134. But he was surprised to learn his new brokerage would reimburse those fees—if he requested it. “Once the transfer takes place, the client needs to fax a statement showing the fee charged, and the brokerage will reimburse it right away,” explains Dalziel. “If investors don’t know this is offered, they could get charged hundreds to thousands of dollars, depending on the number of accounts being transferred.”

Now that Gord is retired, he’s enthusiastic about taking the wheel with his new portfolio. “When I was busy working, it was good to have the feeling that the money was being looked after by an adviser. But once I had more time, and I did more reading, I started asking more questions. Then it wasn’t as easy to put me off with comments like, ‘You’re doing great.’” Now he plans to check in with a fee-only financial planner occasionally to make sure he’s still on track and to get some tax advice.

While the Kirks’ new portfolio is about 85% cheaper than the old one, Gord says he’s just as pleased with the strategy as with the lower cost. “I’ve pretty much got out of individual stocks. I’m often around other retired guys who are passing around information about oil and gas stocks, so I’m tempted, but I’m more disciplined now. I’ve had my 20 years of going to the casino and trying to win the jackpot and now I’m happy to just buy the market. My only regret is I didn’t do this five years ago.”

The Legacy Fund: Clete and Krista Purcell

Clete Purcell’s dad calls him almost every day to discuss the markets. “He’s 80 years old, and he’s been watching BNN for years. When he phones me he’s either delighted or in the depths of depression, depending how his stocks have done.” Over the years, those phone calls have taught Purcell that he doesn’t share his father’s appetite for risk. “He gets a real kick out of it—he’s always been a gambler. But that just scares the hell out of me.”

Clete, 41, is a Vancouver lawyer who represents First Nations clients. “I was at another large firm for 10 years and the partnership track takes a lot out of you. I find this work much more fulfilling.” His artist wife, Krista, 34, is currently home with the couple’s three children, Oskar, Stephan and Lydia, all under seven. She also manages an apartment building the couple co-owns.

The Purcells’ financial situation changed last year when Clete’s mother passed away and they received an inheritance. They’ve decided they don’t want to rely on this money for their own retirement. “We look at this as a legacy fund,” Clete says. “We’re good savers, we plan to continue living frugally and we don’t think we’ll be spending a lot when we retire. So we’re just hoping to do for our kids what was done for us.”

With such a long time horizon, Bender says he would normally recommend at least 80% of the portfolio be invested in equities. But the Purcells are too risk-averse for that. “The most difficult thing for me is the emotional side of investing,” Clete admits. “I’m still logging onto the account every day to see what’s happening, which I know is absurd.”

Bender had several discussions with the Purcells to determine what kind of losses they would be able to tolerate. “We looked at the Monte Carlo simulations,” Clete says, “and Justin showed us what the losses would have been like in specific years—and in dollar terms, not percentages.”

“Percentages don’t mean anything to people,” Bender explains, “but most people know what amount they’re actually comfortable losing. So if they have $400,000, I don’t ask them how they would react to a 25% loss. I ask them what they would do if the account fell to $300,000. If you get this long silence, you know they wouldn’t be able to tolerate it.”

The conversations lasted a week or two, as Clete and Krista carefully considered their options, recognizing that taking too little risk would mean leaving their kids with less, but putting too much in stocks might make them jittery. “I stressed that since they won’t be working with an adviser they’ll need to rely on each other if they’re tempted to sell,” Bender says. In the end they decided to invest 40% of the portfolio in super-safe GIC rates and 60% in stocks (half Canadian, half foreign).

Clete was surprised that Bender did not recommend bonds for the fixed income. “That’s a big mental barrier for a lot of investors,” Bender explains, “because all they read about is bond ETFs.” However, GICs have higher yields than government bonds of the same maturity, with no additional risk. They can also be more tax-efficient, and they have a price stability that most people find comforting. (Unlike bonds, they don’t lose value if interest rates rise.) The only downside is that most GICs are not liquid, but with such a long time horizon the Purcells know they won’t need to sell them before maturity.

Bender helped the Purcells set up their portfolio in a discount brokerage account. They considered dollar-cost averaging—that is, moving into the markets a little at a time to reduce the risk of bad timing. “But at the end of the day, this portfolio is for the long haul. We know we’re going to see both setbacks and great gains along the way, so it doesn’t really matter. Let’s just take control of the things we can control.”

The Purcells still like to keep an eye on the markets, but they’re training themselves not to react to the headlines. “We watch BNN for fun and we’re thinking about setting aside 3% to 5% of our investments as play money,” Clete says. “But we don’t want to have to worry about the how the daily news will affect the rest of the portfolio, that’s for sure.”

A More Comfortable Fit: Jerri Rue

Like many investors, Jerri Rue discovered her risk tolerance the hard way in 2008. “When the market crashed, it just made my stomach turn,” she says. “That December I asked my adviser to move everything into money market funds because I was starting to get sick with the losses. But he talked me out of it. He said we were buy-and-hold, and that the markets would recover.” They did bounce back a little around Christmas, but they plunged again in the new year. “In February 2009, I finally insisted: I just could not do it anymore.”

Rue is a 51-year-old nurse who lives in Selkirk, Man., a small town northeast of Winnipeg. She currently works part-time in acute psychiatric care, but is willing to go back to full-time for a few more years if it would allow her to retire at 55. “I don’t necessarily mean quitting work altogether,” says Rue, who is single and has no children. “I could just work four shifts a month, and with my pension my income would be pretty much the same as my current salary.”

Rue’s defined benefit pension plan will pay her about $2,400 a month at age 55. But she expects to rely on her investments to tide her over until she can start collecting her CPP and Old Age Security. After analyzing her expenses, Bender estimated she’ll need a modest $31,000 after taxes each year in retirement (increasing annually with inflation).

Rue’s investments were until recently in a completely inappropriate portfolio. When she was ready to venture back into the markets in 2009, her adviser rebuilt her portfolio with the same asset mix as before: more than 80% in stocks. “I know moving in and out of markets isn’t the right thing to do,” Rue admits, “but I’ve come to realize that my old portfolio was way out of line. I panicked because it was too risky for me.” While the adviser can’t necessarily be blamed for that—many investors overestimate their ability to deal with losses—there is no excuse for not learning from the mistake. “After the market crash, we should have gone more conservative. But at no time did he ever discuss dialling down the aggressiveness.”

That’s when Rue decided to send her adviser packing. “I have been reading MoneySense for years and the Couch Potato really intrigued me.” She wanted to move her savings to a discount brokerage and rebuild the portfolio herself, but she quickly learned many of her 20 or so mutual funds carried deferred sales charges. That meant making the switch would be far more difficult than she expected.

Also called back-end loads, deferred sales charges (DSCs) were a marketing innovation that appeared in the late 1980s. Back then, it was common for investors to pay upfront commissions of up to 9%—for every $100 you invested, only $91 ended up in your mutual fund. When advisers switched to DSCs, however, there were no upfront costs at all. That sounds appealing, but investors may not have appreciated that now they had to hold their funds for many years or face large redemption fees. DSCs typically start at 6% and decline gradually until they reach zero after six or seven years.

Bender explained that the first step in shedding these funds was to understand exactly what the DSCs would amount to. He asked Rue to call each fund company directly, bypassing her old adviser, who was not inclined to help a departing client. Rue’s task was to learn what portion of each fund she could sell immediately without facing a DSC, what additional amount would mature later this year, the total DSC she would face if she sold everything now, and the final maturity date (when the whole fund could be liquidated without charges).

After a series of frustrating phone calls, Rue learned 10 of her funds carried DSCs, and a clean break would cost her $6,500—a far bigger hit than she was willing to absorb. So she decided on a compromise. She sold the funds with the highest annual fees (more than 3%), getting dinged for $1,500. Then she and Bender drew up a plan for gradually selling the others to sidestep the DSCs.

First she transferred six equity funds in-kind to a new discount brokerage account. Once the funds were under her control, Bender helped her transfer as much money as possible into bond funds in the same family. (Most mutual fund companies allow you to do this without triggering DSCs.) This accomplished two things. First, it reduced her costs, since bond funds tend to have lower fees. Second, it made her portfolio more conservative. From here, Rue plans to sell a portion of these bond funds each year—she can sell up to 10% annually without penalty—and move the proceeds into bond ETFs. Although the last fund won’t be free of DSCs until 2017, she likely won’t wait that long to shake off the handcuffs. “I may come to a point where I decide to just sell them and be done with it,” she says.

Finally it was time to discuss a new asset allocation for Rue and then rebuild her portfolio with low-cost ETFs. It was clear that her original portfolio of 80% equities was far too risky. Bender wanted to make sure Rue’s investments would be able to provide the income she needed in retirement, while recognizing that she might be tempted to abandon her investment plan again. “We eventually decided on 60% fixed income,” Bender says, “but this wasn’t a one-time conversation. It went on for a couple of weeks. She was really hesitant.”

“I never in my wildest dreams would have considered 60% fixed income,” Rue says. “That sounded way too conservative. But when Justin asked how I would feel if I lost different amounts, I came up with some solid numbers, because I knew where I started panicking in 2008. And it turned out to be right around 40% equities.” Bender recommended a mix of GICs in her non-registered account and bond ETFs in the tax-sheltered accounts.

Rue admits part of her was reluctant to give up so much growth potential, but Bender helped her consider the big picture. “We did a lot of work around my pension, my budget, how much I’m going to need in retirement. And we came to the conclusion that even if I didn’t make a whole lot on my investments, I’m still in a really good position. Justin really did a lot of work to bring me around to that.”

Her new portfolio of GICs and ETFs will carry an annual fee of less than one-tenth what she’d been paying for her mutual funds. And crucially, it’s a much better fit with her temperament: with this conservative mix, she won’t ever be tempted to bail on the markets again. “It wasn’t that I was wrong, it was that my portfolio was wrong,” she says. “Now I just feel like this huge weight has been lifted off my shoulders. I used to feel like the carpet could be yanked out from under my feet at any time. Now I’m feeling really good about where I am.”