A capital idea! Understanding core and excess capital

August 27, 2019

You've saved and invested for your dream retirement, and without jeopardizing that goal you'd like to help your children with a deposit for their first home, or put some money to use for philanthropic purposes, or otherwise spend a portion of your savings before retirement. Understanding how much you can spend now and still afford to fund your golden years can be difficult—but knowing what we call your core and excess capital can help you

What is core and excess capital?

Core capital is the wealth an investor needs to retain to support his or her retirement.

In a nutshell, core capital is the wealth an investor needs to retain to support his or her retirement, while excess capital is the amount that can be spent today without affecting those plans.

For example, imagine an Ontario couple, both aged 65 and taking full CCP and OAS benefits. With $5 million saved up and invested, they plan to spend $175,000 each year of their retirement (linked to inflation and after tax). Knowing this, along with the composition and tax treatment of their investment portfolio¹, it's possible to work out how much money the couple is likely to need today in order to meet their retirement-spending aspirations. Happily for our imaginary pair, after crunching the numbers it's around $3.9 million, less than their $5 million invested wealth. The $3.9 million is their core capital, and the remaining $1.1 million is their excess capital, namely what they can afford to spend today and still support their retirement as intended. 

* Core Capital is the assets necessary to have a 90% level of confidence that you will be able to meet your spending over your time horizon. Based on estimates of the range of returns for the applicable capital markets. Core capital relies on all other incomes assumed on the Essential Facts page of this analysis such as CPP, OAS, pensions, etc. Data does not represent past performance and is not a promise of actual or range of future results.

Confidence to determine strategy

Core and excess capital values are based on calculations and forecasts of future investment performance that can never be 100% certain. However, at CC&L Private Capital, we believe we can estimate clients' core and excess capital with a high level of confidence, such that the core capital amount will be able to sustain clients' planned spending even if financial markets perform poorly. We simulate 1,000 potential investment return scenarios, looking for a core capital amount that provides adequate resources in at least 900 of them. This is called the 90^th percentile (90%) level of confidence and many of our clients feel this is an appropriately conservative approach. Of course, if you want more certainty we can plan for that, but it will require a higher level of core capital.

Knowing your core and excess capital can also help in determining the right investment strategy for you.

Knowing your core and excess capital can also help in determining the right investment strategy for you. Take an investor, saving for retirement, who has a portfolio that reflects their moderate risk appetite. Finding out that they  have excess capital above and beyond what they need to fund their retirement may result in a reevaluation of their investment allocations. Their core capital, the amount needed for their  retirement, could remain invested in line with their moderate-risk preference, while they could decide to treat their excess capital differently, depending on their  circumstances. In short, understanding your excess and core capital may help you to make better-informed investment decisions.

1. Our calculation is based on a portfolio with a 45% allocation to fixed income investments and a 55% allocation to equities. The couple is assumed to have $4 million of taxable assets and $1 million of assets in RRSPs.

2 Core capital is the assets necessary to have a 90% level of confidence that an investor will be able to meet his or her spending over a specified time horizon, based on estimates of the range of returns for the applicable capital markets. Data do not represent past performance and is not a promise of actual or range of future results.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.