Problem 3: Case Study in Retirement and Investment Planning

Scherazade Mistry and Daniel Pedro are 55 and planning their retirement at age 65.  They have been managing their investments themselves, and they are quite experienced and comfortable with the volatility of equity investments.  Scherazade is a senior engineering manager with a private auto parts manufacturer in southwestern Ontario.  Her substantial income has provided most of the money for their investments.  Daniel is an abstract sculptor and has had an irregular and fairly low income.  Daniel was the stay-at-home parent, but now that the kids have left home and have established their own careers, he and Scherazade can plan their own future and do some travelling while they are still young.  Even though the kids have left, they still require some financial support and so Daniel and Scherazade do not expect to save much from their income between now and their retirement.

Scherazade’s employer has reasonable health benefits, but no pension plan.  After deducting OAS and CPP for both of them, they expect to need an additional $125,000 (real dollars) in retirement, all of it to be financed by their own assets.  They want to allow for income to age 95.  They have a house worth $2.5 million in a nice neighbourhood.  They plan to sell it and buy a condo for $1.5 million when they retire to help finance living expenses, including the hefty condo maintenance fee.  They have no debts other than the current balance on the credit cards that they pay off every month.  Scherazade has a marginal tax rate of 40%, Daniel a marginal rate of 21% or 0, depending on how many sculptures he sells.  In retirement their average tax rate will be 20%.

They have the following investments:

They also have an unregistered account with one holding:  3,800 common shares of General Motors Corp.  The current market value of the holding is $160,000 in Canadian dollars, which is also the original cost of the investment.  They manage all their investments through an on-line broker with minimal transactions costs, which means they can change their investments without paying a lot of commission.  For this case, assume commissions on transactions are zero.

Magna International, Martinrea, Linamar and Scherazade’s employer are the four largest auto parts manufacturing firms in Canada, all of them with customers around the world.  General Motors is one of the world’s largest auto companies.

They have no contribution room carried forward in the RRSP or the TFSA.

An eminent (define eminent as silver hair and beard, loves skiing, hiking and cycling) finance professor at York University has provided them with the following long run expected nominal asset class annual returns and inflation rate.  These are all before management fees and commissions and assume broad diversification for the equity classes.

Canadian equity 6%

US equity 6.5

International equity 7.0 includes no Canadian or US equity

Canada long term bonds 3.5

Inflation 2.0

Required:

How should they structure their investments to maximise the chances of meeting their retirement objective?  I remind you again that the cash flows are in real dollars.  You can accept the asset values in the case as accurate (I rounded the share prices).  You don’t need to do outside research; use the information in the case.  There is no single right answer to this case.  Show us you can apply what you have learned.