Investment industry worker's portfolio takes too many risks

Dianne Maley

Leonard spent most of his life working in the investment industry, so when it came time to manage his and his wife's $2.2-million in savings, he chose to do it himself.

But a little knowledge can be a dangerous thing. The couple's portfolio took a beating in the stock market meltdown in late 2008 and early 2009 and has not fully recovered.

They are entirely dependent on their investments for their retirement income. Now that their three children are out on their own, Leonard, who is 63, figures he and Lola will need about $100,000 a year to continue to live in the style to which they have become accustomed when he retires, which he hopes will be soon.

He wonders now about his investment strategy.

We asked Warren Mackenzie of Weigh House Investor Services to look at Leonard's portfolio.

What the Expert Says
Leonard's is a portfolio more suited to a 35-year-old stock trader than a 63-year-old soon-to-be retired man, Mr. Mackenzie says.

Much of the $2.2-million portfolio looks like it was assembled for short-term gains rather than prudent long-term growth and preservation of capital, he adds. Leonard has 24.6 per cent in cash (in high-interest savings accounts), 74.1 per cent in mainly Canadian equities and 1.3 per cent in bonds.

A better mix would be 5-per-cent cash and 55-per-cent fixed income, with the stock portion of the portfolio comprising 20-per-cent Canadian, 10-per-cent U.S. and 10-per-cent international. The target return – interest, dividends and capital gains – would be 5.5 per cent a year, Mr. Mackenzie says.

The fixed-income portion could fluctuate between 45 per cent and 65 per cent, depending on economic circumstances. With bond prices high and interest rates low, Mr. Mackenzie recommends a “laddered” bond portfolio with maturities ranging from one to five years but no longer.

A full third of Leonard's holdings are concentrated in two risky investments – a private company with some interest in the oil sands and a former high-flying mutual fund that is “flying a little closer to the ground today.” Although high-risk investments can have a place in a retired person's portfolio, they should make up a relatively minor position, Mr. Mackenzie says.

Even after the stock market recovery last year, Leonard's risky mutual fund is still down 39.3 per cent from when he bought it. His $630,769 investment is worth only $382,762 today.

Because it is a private mutual fund sold on a restricted basis by offering memorandum, the fund bears risks over and above that of a typical stock mutual fund, Mr. Mackenzie says.

Also, the fund is over-concentrated in small capitalization energy and resource stocks, which can be difficult to sell without driving the price lower. Poor performance of the fund could result in redemptions, forcing the sale of its holdings, which could drive the prices even lower.

“This could result in a vicious circle of lower prices for the fund.”

In the past, Leonard has been able to recover from his investing mistakes, Mr. Mackenzie notes. But now that he is heading towards retirement, if Leonard suffers capital losses because the portfolio is poorly managed, he may have to reduce his standard of living in his old age.

What to do?

Mr. Mackenzie suggests Leonard draw up a plan and gradually move the couple's assets into a portfolio more suited to retired people by reallocating $100,000 a month until the proper asset mix is in place.

As it is, he has four different investment managers, none of whom know what the others are doing. “No one is focused on the investing process.”

Spread out as it is over 10 accounts at six different financial institutions, the portfolio is too complicated to manage efficiently, Mr. Mackenzie says. As well, Leonard does not maintain a spreadsheet that shows him how much is allocated to different asset classes.

There is no strategy to systematically rebalance the portfolio, so changes are usually made on an emotional rather than on a logical basis, the planner adds.

In addition, Leonard is paying more income tax than necessary because he is holding his interest-bearing securities outside of his RRSP and his capital gains-producing securities inside his RRSP, where he loses the ability to use the 50-per-cent tax-free portion of capital gains, Mr. Mackenzie notes.

By holding the interest bearing securities in his RRSP instead, he could defer the tax on the interest income.

His financial advisers are not providing him with performance numbers, which would show him how his investments are doing compared to the proper benchmark.

“This is important because if he could see how he was doing and if he know the long-term cost of underperformance, he would take steps to ensure that at least a portion of the portfolio is invested in such a way as to ensure that it does not substantially underperform,” Mr. Mackenzie says.

“On a portfolio as large as this one over a 20-year period, reasonable assumptions show that underperformance of only one percentage point a year will mean [Leonard] will have to reduce his spending by over $1-million during the rest of his lifetime [ignoring income tax],” he says.