Question

John and Jenn are a married couple in their mid-forties. They have two teenaged children, one of whom is going to be starting university in the fall. They have been life-long savers, started contributing to registered educational savings plans (RESPs) when each of their children were born, and have a small mortgage remaining on their home. During their annual review, what changes to their asset allocation would be beneficial?

1. Increase in bond and money market funds to increase interest income. 2. Increase in speculative equities to maximize growth. 3. Increase in equities to minimize taxes. 4. Increase in fixed income to minimize risk.

Answer 1

A couple in their mid-forties who have saved suffciently for their children's higher education and with a small outstanding mortgage should focus on the following changes to their asset allocation. I will dicuss all the options separately and try to deduce a proper logic from the same.

1. Increase in bond and money market funds to increase interest income: At mid 40s,they are still a long way for retirement. With nearly 2 decades from their typical retirement they can still continue to have a large portion of their money in quality equities, equity linked schemes or index based mutual funds. But they should focus on having a balanced mix of equities and bonds & money market funds, since bonds and money market markets though have a lower return than equities but they tend to reduce the overall risk. The balanced portfolio with increased bonds and money market funds will be immune to wild swings in stock markets thereby reducing the overall risk apart from generating interest income.

2. Increase in speculative equities to maximize growth: This is not at all a good option considering their age related risk appetite. Speculative equities though sometimes have the capacity to generate high returns but more often than not the value of speculative equities move southwards and can stay at lower prices for longer periods. The value of such investments can reduce to nothing as well.

3. Increase in equities to minimise taxes: As has been discussed earlier that having quality equities along with equity-linked savings schemes, index mutual funds etc. which are good options for minimizing taxes should be considered not only for tax savings but for generating higher returns as well. Here, the investment should be done for long-term. A couple who has 15-20 years for retirement should be focusing on their retirement plan which can be achieved by increased invest in equities and related items.

4. Increase on fixed income to minimize risk: Fixed income can be increased either through active or passive ways. It is always desireable to have high fixed income but for that they need to dedicate more hours for increasing their active incomes. Working longer will bring in more income which can then be invested for having a better, secured retirement. Passive income is generated from the investments made so it can be said that increase in fixed income will have double impact on retirement plan thereby minimizing risk.   

The income which was earlier moving towards RESPs & repayment of mortgage should now gradually be channelized towards equity-linked products, bonds & money market funds with a ratio of 60-40. It may vary slightly as per the risk apetite of the couple. There should also be a gradual increase in allocation towards bonds and money market as they grow old from the current 40%.