Building your RRSP
They allow their money to earn far less than it should and fail to keep track of their RRSP investments.The result can be extremely costly. By improving your RRSP earnings by just a couple of percentage points each year, you can add tens or even hundreds of thousands of dollars to the final value of your plan.To achieve that, however, you have to look after your money. Your RRSP represents an investment portfolio, perhaps the largest one you’ll ever have. You may have never thought of yourself as an investor, but the moment you open an RRSP you become one. How well you manage your money will have a significant impact on your comfort level after retirement.
Here are some quick tips to help you get on the right track:
Invest only in things you understand. The list of possible RRSP investments is long and ranges from the relatively simple, like CSBs, to the ultra-sophisticated, such as covered call options. Stay with securities with which you are comfortable and you won’t go far wrong.
Diversify your plan. Don’t put all your RRSP eggs into one basket. The best-performing RRSPs contain a mixture of securities. A diversified approach will impre your prospects for better returns while at the same time reducing your risks. The best way to achieve this is by using an asset mix approach.
Invest for the long haul. You and your RRSP are going to be together for a long time. Your investment strategy should reflect that. Virtually every decision you make should have at least a five-year horizon, with the exception of cash movements. That doesn’t mean you should never sell a security you’ve held for less than five years, but you should have an extremely good reason for doing so. The biggest mistake most novice investors make is to trade too frequently. In most cases, you’ll be much better off making sound investment decisions at the outset and then holding the security for several years.
Keep your costs low. Any money your RRSP spends on fees or commissions is lost to the plan forever. That’s why you should keep such charges to a minimum. If you’re purchasing mutual fund units, favour no-load or back-end load funds (in cases where you’re not saddled with high management fees). If you buy a front-end load fund (which means sales commissions must be paid at the time of purchase), negotiate the lowest possible rate (4 percent should be the maximum; discount brokers usually charge around 2 percent, and in some cases you can obtain front-end load funds at zero commission—the seller does this to obtain the annual trailer fees).
Keep your losses low. Since you can’t replace RRSP money lost as a result of bad investments, you should do everything in your power to keep any losses to a minimum. That means avoiding speculative investments and not selling high-quality securities if they go into a temporary slump because of corrections in the stock or bond markets.
Maximize the effect of compound growth. The key to building a million-dollar-plus RRSP is steady compounding over many years. Your plan should include securities that maximize the effect of this, such as high-yielding bonds, strip bonds, mortgages, and GICs.
Pay attention. Review your RRSP holdings at least once every three months to see how well they’re performing and if any adjustments are required. You should also review every statement you receive from the company administering your RRSP. Errors creep into these reports occasionally; check to make sure that you’ve received credit for all interest and dividends and that the administrator’s list of your assets corresponds with yours.
Contribute regularly. RRSP contributions shouldn’t be determined by whatever’s left over in your bank account. A regular contribution program, preferably on a monthly basis, will ensure your plan continues to grow at a steady rate and will eliminate the last-minute scramble for cash at deadline time. Many RRSPs now offer an automatic deduction plan, which enables you to authorize a specific amount for transfer from a deposit account into your RRSP at regular intervals.
Don’t ignore stocks. There is a raging debate among financial experts as to whether stocks should be included in an RRSP. Under ideal circumstances, they should not because you lose the benefits of the dividend tax credit and the favourable capital gains tax rate when stocks are held inside a retirement plan. You’re better off keeping the stocks outside the plan and holding more highly taxed interest-bearing securities in the RRSP. But that assumes you have adequate assets to run two investment portfolios. Most people don’t. If your RRSP is your only investment portfolio, we recommend you hold at least some stocks in your plan, preferably in the form of high-quality equity mutual funds. The younger you are, the stronger this recommendation. That’s because, over the long haul (which is, after all, what we’re discussing here), common stocks have a better growth record than any other type of investment you can make.
A study done by Scotia Capital Markets illustrates this. During the 35-year period from 1963–98, the average annual return for an investment in the stocks which make up the Toronto Stock Exchange’s 300 Index was 10.37 percent. Money invested in long-term bonds would have earned an average of 9.6 percent a year, while funds held in 91-day Treasury bills would have returned an average of 8.03 percent annually.
One of your RRSP investment objectives should be to stay well ahead of inflation. That’s very difficult to do without including at least some stocks in your plan.
Adapted from Gordon Pape’s 2000 Buyer’s Guide to RRSPs by Gordon Pape and David Tafler, published by Prentice Hall Canada