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Best investment for couple? Pay down mortgage(ZT)

(2007-04-21 04:57:09) 下一個

Best investment for couple? Pay down mortgage

Saturday, April 21, 2007

In Vancouver, a couple we'll call George, 39, and Patricia, 38, have good lives. Both scientists, they gross $124,411 a year and receive $3,400 a year in benefits for their three preschool children. Their house, which they bought in 2002 for $325,000, has doubled in value. In that gain lies their dilemma.

“We feel fortunate and we are well off, but we worry about our financial future,” George explains. “We would like to retire comfortably at age 65, but we also want to be able to start a small business or perhaps take a year off to go travelling,” he explains.

Capital appreciation has made him aware that his family's future now lies in a substantial way with the real estate market. His problem: How to mobilize the gain without selling it and moving out of Vancouver or taking the risky step of borrowing against it and investing the cash elsewhere.

“We are at a point in our lives in which we want to be sure that we are making the right financial decisions,” George says. “We want to use our fortune wisely.”

What our expert says

Facelift asked Vancouver-based financial planner and portfolio manager Adrian Mastracci of KCM Wealth Management to work with George and Patricia to devise an answer for their problem: How to unlock the value of their house in order to educate their children and plan for their retirement. He says they cannot unlock the capital gain in their house, but they can build on it.

“The purchase of their home has been a terrific investment,” Mr. Mastracci notes.

“They also bought early stage shares in George's company. One day they may produce a gain. But right now, their portfolios need a makeover.”

The couple also need to find a way to boost their savings. They are saving $781 a month, including $150 of registered retirement savings plan contributions. They would like to save far more.

In one sense, they are already doing that, for their house is gaining value in the Vancouver market. Even at a modest 5-per-cent annual rate of growth of its market price, $32,500 a year, they are getting a tidy return on a secure asset.

Their other investments, including their RRSPs and registered education savings plans for their children, have not performed as well as their single real estate holding.

George contributes to a group RRSP at his place of work, but the choices for investment are limited. However, he can transfer the money to an RRSP in his own name. He has $18,700 of unused RRSP room. Patricia has $23,300 of unused RRSP space.

The easiest investment decision to make is to pay down the mortgage, Mr. Mastracci says. It carries an interest rate of 4.5 per cent. The pretax equivalent cost of the mortgage is 6.7 per cent, he estimates.

George and Patricia could beat that in the stock market or with some mutual funds, but it is better to compare the return to that of a risk-free government bond. Ten-year Canada bonds now pay 4.1 per cent a year. The return from mortgage reduction beats that without question, the planner notes.

The couple's mortgage allows annual contributions of up to 15 per cent of the outstanding amount without penalty. Once the mortgage is eliminated, the couple can allocate the $21,600 they spend each year on that debt to savings, either boosting their accumulation for retirement or raising the amounts they contribute to their RESPs. Leaving the mortgage payments as they are now will require 11 more years to discharge the debt, Mr. Mastracci figures.

Growth of capital that can be accessed without giving up their house will have to come from other investments, the planner says. In sketching out what their investment portfolio should be, Mr. Mastracci assumes that George will live another 44 years and that Patricia will live another 49 years. In each case, their life expectancy has an extra five years added for conservative planning.

Inflation is assumed to run at 3 per cent a year and gross investment returns at 6 per cent a year. George will get maximum Canada Pension Plan benefits, currently $10,365 a year, while Patricia, with a lower salary, will get 70 per cent of the maximum CPP benefit. They will both qualify for Old Age Security, currently $5,903 a year, the planner notes.

With those assumptions, the couple will need $2,700,000 of capital when George reaches 65 to finance their retirement goal of $85,000 pretax 2007 dollars on top of their CPP and OAS pensions, Mr. Mastracci estimates. George adds $14,000 a year to his group RRSP. He and Patricia also want to save $1,800 outside of the group plan.

If they use the remainder of their $481 monthly savings, they can save $20,000 a year. Patricia's employment pension should pay them $7,000 with indexation to changes in the consumer price index. The OAS clawback, which begins at $63,500 in 2007, should not affect them if government proposals for pension splitting become law

Building up capital should be done in stages, Mr. Mastracci advises. First, the couple, with $3,000 in cash in their chequing account, should develop an emergency fund able to cover six months of expenses. Once that is in place, George should make all RRSP contributions to his own plan. Because he is in a higher tax bracket than Patricia, George should make all contributions and endeavour to balance his RRSP and his wife's fairly evenly. Some RRSP contributions should be used to repay a $10,000 loan the couple has taken through the Home Buyer's Plan.

As capital pours into the RRSPs, Mr. Mastracci advises that George and Patricia allocate it so that George has 60 per cent equities and Patricia 50 per cent equities. Fixed-income securities or funds can make up the difference.

Geographically, George should put 30 per cent of total financial assets into Canadian stocks or funds, 20 per cent in U.S. stocks or funds and 10 per cent in global stocks or funds. His fixed-income allocations should be in a three-to-four-year bond ladder and 15 per cent into securities that pay significant dividends. Patricia can have a similar allocation: 25 per cent Canadian securities, 15 per cent U.S. investments and 10 per cent global assets. Her fixed-income allocation should be 35 per cent in a three-year bond ladder and 15 per cent in dividend-paying stocks, the planner suggests.

Their children's RESPs can dispense with liquidity concerns for now. The money will not be needed for a decade at the earliest. Therefore an allocation of 80 to 100 per cent in equities would be acceptable, the planner says. Currently, George and Patricia add just $150 a month to the RESPs of their own savings but the plans also receive occasional contributions from other sources sufficient to push them up to the $2,000 per child level, at which each child receives the maximum Canada Education Savings Grant of the lesser of $400 or 20 per cent of the amount contributed, Mr. Mastracci notes.

George and Patricia would like a sabbatical in perhaps five years. It's good to take time out from a career, Mr. Mastracci says. As well, it is a chance to try out retirement. Financing the year off can be done creatively, he suggests.

One way is to ask the employer to pay 80 per cent of salary for four years and then the remaining 80 per cent of one year's salary can be paid in the fifth year. Alternatively, George and Patricia can set aside 20 per cent of their salaries for each of the next four years.

“George and Patricia have done a lot of the right things,” Mr. Mastracci says.

“They cannot wring equity out of their house without a sale or borrowing against it, but they can do other things to improve their returns. The best move is to pay down the mortgage and once that is done, they can concentrate on building up their financial assets.”

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