Help clients preserve their capital

When clients start cruising toward retirement, advisors need to help them preserve capital by keeping an eye on both the asset mix and where those assets are housed, says Kostas Andrikopoulos, president of KNA Strategic Wealth Consulting in Toronto.

We gave him the scenario of a couple with between $500,000 and $1 million invested (75% in an RRSP, with the remainder in unregistered investments; they’ve never opened TFSAs). They’re currently ages 55 and 53 and plan to retire at 67 and 65. Both are wage earners but neither has a DB or DC workplace pension. They own their principal residence outright but have no cottage or other real estate. Their doctors say they’re in excellent health and will easily break 90.

In terms of tactical options, Andrikopoulos says he’d perform an analysis to determine which of the couple’s assets produce the highest returns and then crunch the numbers to see if anything should move in or out of their registered accounts.

“If you have a dividend-paying stock, and it’s paying about 1% or 2%, you may want to leave that in the unregistered portfolio,” he says. “Whereas if you have a dividend-paying stock of 9% or 10%, you may want to put that in your RRSP.”

Yes, you’d be forgoing the dividend tax credit, but if you have a Dividend Reinvestment Plan, then the whole amount would get reinvested until the couple are ready to pull it out.

And, while conventional wisdom suggests anything paying interest belongs in an RRSP and anything generating dividends should remain outside, persistent low interest rates have changed the picture.

“With interest rates at 1% or below, it may not make sense to have it in an RRSP,” says Andrikopoulos. “It may be wiser to have a dividend-paying stock at the 4%, 5% or 6% range inside the RRSP so the dividends are paid into it with no taxes. And, if you’ve got a DRIP plan, it’s the gross amount that gets reinvested – not the net amount after tax.”

Dividend-payers also should be sifted to ensure they’re providing sufficient value. “I don’t invest in stocks that don’t pay dividends and don’t regularly increase the dividend payout,” he says. “There are correlations between the dividend being paid out and the value of the stock. The telcos, for instance, have a pretty good success rate in terms of the value appreciation and increase in dividends. But you can’t put everything into one stock.”

Andrikopoulos adds it’s a no-brainer for each member of the couple to open and place $52,000 into a Tax-Free Savings Account. “That’s at least $104,000 combined in the TFSAs,” he says. “You’re sheltering the money from taxes until you’re ready to pull it out. Furthermore, the TFSA is a lot more flexible than an RRSP in the sense you don’t have to start pulling the money out at 71.”

In terms of asset mix, he notes the couple should be easing some risk out of their portfolio. At their current ages, a 50% to 60% equity range “is not a bad place to be, with the rest in bonds or cash equivalents, or just a fixed-income component.” Once they cross into 65, the equity portion should shrink to between 30% and 40%, but can’t be eliminated too soon because they’ll need decent returns in their early retirement years to counter longevity risk.

Andrikopoulos also suggests adoption of a stop-loss rule – something he incorporates for his own investments. “It goes a long way in preserving capital. When you’re placing at a fund, always check on the capital preservation and defensive mechanisms,” he says. “The stop-loss order could be triggered at, say, 10%.”

And be careful not to set the percentage too low or it could be triggered by routine market fluctuations. “Volatility we used to see over the course of a year 20 to 30 years ago can happen over the course of a week now,” he says. “You don’t want to be too trigger happy. That doesn’t help the client.”

Lastly, should interest rates tick up, it may be worthwhile to consider annuity investments to provide an income stream.

“It’s something to consider down the line,” says Andrikopoulos. They can be funded with assets kept in cash or cash equivalents – or the client can redeem other investments to make the purchase.

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Philip Porado is a veteran Toronto-based journalist who specializes in financial and business topics. Prior to immigrating to Canada in 2004, he covered brokerage compliance, real estate, housing policy, architecture and technology for several U.S. publications.