Money Smarts: Look To The Future With Your RRSP
What do you do about your RRSP when the whole world seems to be going crazy? The answer is simple: ignore all the background noise and carry on as before. Your RRSP is going to be around a lot longer than Donald Trump!
I admit it’s not easy to tune out everything that’s happening in Washington. Not a day goes by without some Trump pronouncement grabbing the newspaper headlines and the lead slots on the television news.
And it’s true that some of his words and actions are going to have a negative effect on stocks. The turmoil that followed his immigration order riled the markets, with the Dow recording triple-digit losses for two straight days after it was proclaimed and courts weighed in on its legality.
But all this will pass. Pension fund managers never worry about the day-to-day movements of the indexes; they focus instead on investing in sound, long-term securities. Your RRSP is simply a small pension plan so you should adopt the same psychology.
Here are some tips on how to get the most out of your RRSP, this year and every year.
Review your asset allocation. You should have established a target asset mix when you set up your plan (if you didn’t, do it now). This is a good time to review it.
For starters, go through your portfolio and allocate each security into one of three categories: cash, fixed income, and growth (stocks). In the case of balanced funds, check how their assets are distributed and apportion them in your portfolio accordingly. For example, you may have a fund that is 50 per cent in stocks, 45 per cent in fixed income, and 5 per cent in cash. The allocation in your RRSP should follow the same pattern.
Once that is done, review your overall portfolio mix. Since 2016 was a good year for stocks, you may find the growth portion is a little top-heavy for your risk level. That can be corrected in two ways: either by adding new money to your fixed income or cash positions, or by selling some stocks or equity mutual funds and moving the money into the other two sectors.
It is essential to complete this review before you make any decisions on where to invest this year’s RRSP contribution. The result will guide your decision as to what type of investments to consider.
One more thought. The closer you are to retirement, the more conservative your asset mix should be. Stocks have been very strong in the past few years but the market looks expensive at this point. If retirement is only a year or two away, you don’t want too high a percentage of your assets to be at risk in the event of a crash.
Invest for the long term. I have an acquaintance that recently invested $15,000 in a penny stock in his RRSP. The stock jumped more than 250 per cent in just 10 days and the value of that investment soared to almost $40,000! True story!
Windfalls like that are great to read about but I would not try to emulate them in your own retirement plan. More often than not you’ll end up losing your money. You’ll never find a professional pension fund manager who buys penny stocks with his clients’ hard-earned savings. You shouldn’t either.
Rather, you should adopt a long time horizon when choosing securities. How long depends to a large extent on your age, but 10 to 20 years is reasonable. Of course, you should revisit your holdings periodically to see how they are performing but the basic rule is to choose securities that you will be comfortable owning for years to come.
For growth, look at dividend-paying stocks like Enbridge, TransCanada, Brookfield Asset Management, CN Rail, BCE, TD Bank, Fortis, Telus, etc. These are bedrock companies that will continue to grow and enhance your bottom line.
If you prefer to invest in funds, consider SPDR S&P Dividend ETF, iShares Core S&P/TSX Capped Composite Index ETF, Beutel Goodman American Equity, Mawer Canadian Equity, and Leith Wheeler Canadian Equity.
The fixed income side of your portfolio may seem a little trickier right now but here again focus on the long term. Rising interest rates may drive down the price of bonds for the next year or two, but that will not always be the case.
If you have enough money in the RRSP and deal with a brokerage firm that maintains a bond inventory, you can purchase individual bonds or strips for your plan. The advantage is that you’ll receive the full face value at maturity (assuming you choose high quality bonds) while receiving predictable cash flow in the interim.
Most investors prefer to use funds for their fixed income holdings because they are easier to purchase. The iShares Canadian Universe Bond Index ETF is a good choice for a long-term hold.
Decide between RRSP and TFSA. If you have a lot of money to invest, I advise using both plans. If you only have a limited amount of cash, you’ll need to decide between them.
The RRSP has the advantage of an instant tax break. Your contribution will generate a refund, calculated at your marginal rate. If you’re in a 40 per cent tax bracket, you’ll get $2,000 back on a $5,000 investment. Not a bad return!
The downside, of course, is that you’ll pay tax at your marginal rate when the money is withdrawn from the plan (or from a RRIF) years down the road. I have had many people write to me bemoaning the high level of taxes they have to pay as a result. RRSP/RRIF income also impacts your tax credits and GIS payments, if you qualify.
The biggest tax hit comes when you die. If there is no surviving spouse, the government deems that all the money in an RRSP/RRIF is taken into income in your final year and your estate is taxed accordingly at the marginal rate. The final tax bill could be in the tens or even hundreds of thousands of dollars.
Tax-Free Savings Accounts don’t come with that baggage. There’s no tax refund now but in exchange there’s no tax grab in the future. All withdrawals are tax-free and at death your heirs will inherit all the proceeds, again tax-free.
So the choice is short-term financial gratification vs. long-term pain (RRSPs) or short-term pain vs. long-term gain (TFSAs). Here’s a tip: if you have any reason to believe your income will be higher in retirement than it is now, choose the TFSA.
Whatever you decide, the key is to tax shelter as much money as you can. Canadian tax rates are high so do everything you can to minimize the bite on your wallet.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.