[1.] Given the volatility and uncertainty in the stock market -- and the fact I am getting much closer to my actual retirement date when I need to spend money from the nest egg – should I be moving to a more conservative bond-based asset allocation?
Quick Reply: In general, there is a consensus amongst financial experts that an individual’s target asset allocation -- which is the mix of risky stocks versus safer bonds -- should become more conservative as they grow older. At some level, it should be quite obvious that a 95 year-old grandmother should have a safer portfolio compared to her 35 year-old granddaughter. However, there is quite a bit of disagreement between experts regarding the rate at which people should reduce their asset allocation as they age. Some have defended the use of a simple formula which dictates that you should have your age in bonds, while others (like me) have argued that the “age = bonds” is much too conservative. Personally, I think that “square root age = bonds” is a better approximation to the truth, especially when you consider human capital and pensions. Anyway, this debate has been ongoing for decades and started well before the current turmoil hit. If anything, though, the recent volatility is likely to tip the “thinking” scale towards a more conservative allocation for everyone.
[2.] Unlike teachers and government employees, for example, who have a defined benefit (DB) pension with guaranteed lifetime income, I must rely entirely in my RRSP for anything above the basic CPP entitlement. Is there any way to invest or purchase something like a pension in the retail marketplace?
Quick Reply: The short answer is yes. The easiest way to do this is by going to an insurance company/broker/agent, who can help you purchase a personal pension, which is sometime called a single premium immediate annuity (SPIA). This product comes in various types, shapes and forms so make sure to consult an expert (or become one) before you irreversibly annuitize a portion of your retirement nest egg. In fact, if you do not have access to a DB pension (other than the Canadian Pension Plan or U.S. Social Security) I would strongly urge you to consider allocation a fraction of your nest egg to these products. Make sure to get a COLA-adjustment, though.
[3.] I am terribly distressed by the amount of money my RRSP/portfolio has lost in the most recent bear market. My financial advisor claims that I should “do nothing” since it will eventually come back. Is that true? Can I trust him? Why didn’t the experts see this coming?
Quick Reply: First, I can’t really tell you whether your financial advisor is trustworthy. Most of them are honest professionals trying to make a decent living. Now, there is no way your advisor could have predicted or foreseen the severity of the current financial storm, no more than a basic physician can safeguard you from an unforeseen outbreak of SARS or West Nile Virus. Everyone in the financial services industry – from Alan Greenspan down to the shoe shine boys on Wall Street – has been shocked by the number of unprecedented events that have taken place in the last few months. However, I also think that it is a mistake to sit-back and do nothing, claiming it will all come back. We have learned some very important lessons regarding the fragility of the financial system and some sacred calves have been slain in the process. Make sure your advisor tells you how – exactly – he or she is absorbing what they have learned in the last few months, and what this means to you. Complacency is not a financial strategy.
[4.] How exactly to the new TFSA work? If I have only a little bit to invest, should I use the TFSA instead of an RRSP? What investment/assets should I place within a TFSA and what should I hold in the RRSP?
Quick Reply: There have been quite a number of good newspaper columns and articles written about this in the Globe and Mail as well as National Post during the last few months. Overall, I think that you should place highly taxed assets (like bonds) inside the TFSA, which is actually kind of obvious when you think about it. Overall, if you only have limited funds to contribute to one of these vehicles, it would really depend on your marginal tax bracket. At low levels I would favor the TFSA, at higher levels I would favor the RRSP. Think tax refund. That said, there are many moving parts to this equation, and it really, really, depends on circumstances. I hate to cop-out like this, but personally I would use BOTH of them and diversify tax uncertainty since good arguments can be made on both sides of the debate. Similar hedging thinking has been applied to the ROTH IRA in the U.S., which is based on the same idea.
[5.] My financial advisor has told me about a strategy called an RRSP meltdown in which I collapse my RRSP well before age 70 and then borrow money so that interest paid offsets the tax due. Does this strategy make sense to you?
Quick Reply: Ugh…Ok. In theory, this all depends on your (marginal) tax bracket now versus your expected tax bracket in retirement. If the gap between them is relatively large, i.e. you might face a higher tax rate when you withdraw larger sums from your RRSP/RRIF in retirement, then yes it might make sense. Overall, although there is some merit in these tax arbitrage strategies when interest rates are relatively low, please consult an expert before you do something like this, especially since it is irreversible.
[6.] A number of insurance companies, such as SunLife, Manulife and others have launched something called Guaranteed Minimum Withdrawal Benefits (GMWB) which supposedly guarantee that I will never lose money. But the fees on this are very high and cost a total of 3% to 4% in some cases. Do they make sense to you? They seem to be selling quite briskly.
Quick Reply: I have written quite a bit about these products in a variety of magazines and journal articles. See the articles section at www.ifid.ca for an in depth analysis of the pros and cons. In general, yes, I am an advocate of this family of new products that I call Guaranteed Living Income Benefits (GLiBs) – for people within the “retirement risk zone” who can’t afford the time needed to recover from market losses. And, although the fees are quite high, the actual insurance component (as opposed to money management component) is fair and reasonable. In other words, you are paying about 1.5% of assets for insurance, which is justified. In fact, I wouldn’t be surprised if these costs increase in the next year. The other 2% to 3% is for active money management. That is another matter, and don’t get me started about that…
[7.] I have been hearing and thinking about something called a “reverse mortgage” offered by CHIP. It sounds like I don’t have to pay anything until I move or sell the house. Is this a good way to supplement retirement income? Will my kids be burdened by this? I am concerned about having debts in retirement.
Quick Reply: First of all, I don’t think there is anything wrong with having debt in retirement. On a general level, if you have a house worth $500,000 and very little income, it makes no sense to me to starve yourself so that your children or grandchildren can inherit an expensive house (that they might sell anyway.) Don’t confuse dying broke with dying in debt. The former implies your asset are worth less than you liability (which is bad). The latter implies you have ample assets to pay-off debt (which is good). They key, in my mind, is to make sure you are paying a reasonable (i.e. as low as possible) interest rate on your debt, since you will likely be carrying this burden for the rest of your life. And, to make a long story short, I think the current generation of “reverse mortgage” products have a away to go before they earn a high grade in my course. I am actually a (bigger) fan of shared appreciation mortgages for the elderly – which have been available for some time in the U.K. – which hopefully will get imported to Canada, soon.
