By Michael Demner

Introduction

In planning for your retirement, you will need to make decisions about your investments and where to invest your retirement savings so that you can enjoy a comfortable lifestyle throughout retirement.

There are several sources for retirement income, including RRSPs, TFSAs, investment accounts, bank accounts, and lines of credit (home equity).

For most of these resources, the plan member needs a reasonable understanding of the pros and cons of different investments and how to maximize their value over time. Relying solely on financial advisors (such as banks) without understanding how their advice might impact your retirement income is typical, but it can have detrimental results.

Investment Funds

There are numerous types of funds for investments, but the following are the major categories for individual investors:

• Short-term investments and GICs usually provide an annual rate of return of between 1% and 2% per year, or a bit less than the rate of general inflation.
• Bonds can be expected to provide an annual rate of return of between 2% and 3% per year or a bit above the rate of general inflation.
• Canadian equities can be expected to provide an annual rate of return of between 4% and 6% per year, over a minimum of 5 years. These investments can be highly volatile and are guaranteed to go up and down as global economic conditions change.
• Foreign equities are expected to provide an annual rate of return of between 4% and 6% per year, over a minimum of 5 years. These investments are even more volatile than Canadian equities and may be subject to currency fluctuations.
• Balanced funds are a combination of bonds and equities and are expected to be less volatile than equities yet still earning annual rates of return of 4% to 5%.

Investment Managers and Advisors

Banks, insurance companies, and mutual fund brokers all offer mutual funds to the general public. Mutual funds are investments that have been established by management companies for the general public and require government approval. There are many types of mutual funds, for example investments in Japanese stocks, and the choice is almost endless. The performance of these funds varies widely and no one fund is guaranteed to always produce the best return on your investment.

Other investment companies specialize in the investment of pension funds, endowments and other securities and typically their fees will be lower than for the mutual fund companies and banks.

Even lower fees can be obtained through organizations such as BenFlex Services who negotiate contracts with the investment companies at low fee rates and have low overheads through online application and communications with their members.

Each investment fund manager has their own style of investment, which can be successful in some years and not in others. No one manager can be shown to be far superior to any other manager over the long term.

Fees for Investment Management

All financial advisors and investment managers charge a fee for their services.

Investment managers charge their fees through a management expense ratio (MER) while financial advisors and brokers charge their fees through commissions.

MERs charged by banks and mutual fund companies are typically between 2.0% and 3.0% of the assets under investment. Commissions and brokerage fees could reduce your investments by up to another 1.0%. Investors often do not see the fees charged since the investments are “unitized” and the cost of investing reduces the unit prices. Unitization is the method by which investment companies allocate their mutual funds to investors so that each investor owns a fixed number of units. Unit prices change over time as market conditions change, and a member’s investment is equal to the current unit price (which typically changes daily), multiplied by the number of units they own.

MER’s charged by investment companies and for pension funds would be in the range from 0.5% to 2.0% of assets. BenFlex Services fees, including the fund MER’s, range from 1.0% to 2.0% of assets and this includes custom services such as retirement and financial planning at no additional cost for clients with investment accounts over $50,000.

Choosing an Investment Managed and Advisor

The following characteristics should be considered when hiring an investment advisor who in turn will offer their suite of investment funds:

• Disclosure of all fees and service costs. Fees, commissions and service costs can occur at the front-end (the time of purchase), while investing, and at the back-end (the time of sale).
• Ability to understand the purpose of the investment—for retirement or a home purchase for example—to propose an investment strategy that will meet the required objectives.
• Ability to offer other services, such as estate planning or retirement planning, cost-effectively.
• Ability to sympathize with the client and to prioritize the client’s needs over personal financial gain. It is very rare to find someone in this category, particularly at the banks.

Choosing an Investment Fund or Strategy

Developing an investment strategy and selecting an investment fund depends on what the investment will be used for, when the money is required, and how it should be paid—as a lump sum or monthly payments, for example. If additional funds are to be invested regularly, this can also make a difference to the investment strategy.

Your tolerance for risk should be assessed to see if you are likely to worry about investment losses or are more likely to accept that these will occur from time to time.

Finally, the amount of investment fund required for future access will determine the rate of return and hence the need for a riskier investment than short-term bonds or GICs, for example.

A proper financial plan should be developed rather than just saying: “Get me the best you have to offer!”

Comparison of Investment Funds

This section illustrates the different rates of return experienced by various investment funds, after all fees and expenses.

Typical Balanced Funds

This chart compares the performance of a typical balanced fund with bank funds (RBC) and two Vancouver-based investment managers (Phillips Hager & North and Leith Wheeler) who are included for investment under the BenFlex Group RRSP (click here for more details):

Performance of Different Types of Investments

This chart compares the performance of the different types of investments for a single manager to show how volatile some investments can be:

Example of an Investment Strategy - Retirement Plan

You are a 55-year-old BC Public Service Pension Plan (BCPSPP) member and you want to retire in 5 years, at age 60. You are single, with an adult, self-sufficient child.

Your pension statement indicates that if you retire at age 60, your pension income will be $2,500 per month until age 65, then reducing to $2,100 per month.

You recently received a statement of earnings from Service Canada for your Canada Pension Plan showing that if you were age 65 now, your CPP benefit would be $1,100 per month. You have been told that if you retire at age 60 and you take your CPP early, then there is a reduction in monthly payments of 36%.

You have been informed that you will be eligible for Old Age Security (OAS) starting at age 65, for the full amount which is currently $615 per month.

You currently have $50,000 in RRSPs and $20,000 in your bank accounts.

Your take-home pay, currently $3,000 per month, is sufficient to pay your living expenses. You own an apartment that has no mortgage and expect to continue living there during your retirement.

You want to travel at least once a year to see your son and his family who live in PEI and you anticipate additional travel expenses of $5,000 each year.

You believe that you can earn a minimum of 3% each year on your investments.

Can you retire and live comfortably? If not how much more should you be saving? How much do you need to earn on your RRSP’s?

Here is an example of the MyPRIM analysis in the Retirement Advice for Canadians website:

• After income tax, your total take-home income from CPP and BCPSPP at age 60 will be $3,100 per month.
• Adding in RRSPs and your investments earning 3% per year, your total income is expected to be $3,500 per month. This is sufficient to maintain the same standard of living as before you retired and includes a travel allowance.
• After age 65, your SPP reduces and OAS starts at age 65, resulting in a total net income of $3,200 per month. This is approximately $300 per month short of the total needed to maintain the same standard of living as before retirement and also include a travel allowance. You would have to earn a rate of return of over 20% per year on your investments to eliminate this deficit! Instead you could save an additional $250 per month and still only have to earn a 3% annual rate of return to maintain the same standard of living.