Plan your RRSP strategy for 2002

It’s been very tough the past two years. The high-tech crash that began in the late winter of 2000 continued with only brief respites right through the first half of 2001. It wiped out hundreds of millions of dollars in mutual fund valuations.

Investors were left shocked, shaken, and unsure of what to do next.

We warned last year that the high-tech area of investing was not well suited to RRSPs because of the volatility involved. We wrote then:

“The gains can be spectacular, as we have seen. But the risk to capital is significant and not one that should be taken lightly. A severe market correction, such as the Nasdaq exchange experienced in the spring of 2000, can quickly knock 25 to 30 per cent off asset values. Therefore we recommend that RRSP investors be very selective about their equity exposure to higher-risk areas.”

New economy troubled

Of course, this is exactly what came to pass. RRSPs that were overloaded with high-tech stocks and mutual funds took a terrible beating as the New Economy sector staggered.

Registered plans that had maintained a good balanced between growth and fixed-income securities and had oided the temptation to invest heavily in technology funds fared much better.

Bond expectations

One of the mainstays of RRSP investors, the bond market, suffered through a difficult period in 1999-2000. But bonds regained some of their lustre in 2001 as the U.S. Federal Reserve Board and the Bank of Canada embarked on an interest-rate-cutting policy to try to revitalize the slumping economy.

In the days following the terrorist attacks, bonds strengthened even more as interest rates fell even more in an effort to stabilize a shaken economy.

We believe that the coming year will see a slowing of this process and a stabilizing of rates. Therefore, we expect only average returns from the bond market over the next 12 months. Counterbalancing that is the safety of principal offered by good-quality bonds, a very important consideration at this time.

Next page: Watch for these signs

Watch these signs

Here are some of the things to watch for in the year ahead:

Economic recovery: At the time of writing, it appeared almost certain that North America would slip into recession in the second half of 2001 as a consequence of the economic disruption caused by the September attacks.

What is not predictable is how long that will last. When the signs of recovery begin to emerge, hopefully at some point in 2002, it could set off a tremendous stock market rally.

When that happens, be ready to commit some of your cash to high-quality equity funds and lighten up your bond holdings.

Inflationary trends: Last year we predicted that the inflationary threat that was starting to emerge would diminish as the economy slowed. That is precisely what has happened.

We do not expect inflationary concerns will be a serious issue in the coming year, especially in the light of the events of September. In fact, deflationary worries may emerge as a more serious concern.

Stable interest rates: Interest rates could continue to trend lower through early into 2002, but should then stabilize, assuming the economy starts to recover.

Stock markets: Trying to predict the bottom of a bear market or the top of a bull market is a fool’s game. No one has successfully managed to do it consistently, not even the most astute stock market experts. So you shouldn’t even try.

Minimize RRSP risk

Your RRSP investment strategy should be to keep your risk to a minimum.

• Weight your portfolio towards cash and fixed-income funds.
• Select only high-quality, broadly-based equity funds for your growth holdings, within the limits that you have set for yourself.
• We suggest no more than 50 per cent equity investment in the current climate.
• Emphasize equity funds that use a value approach to stock selection.

These funds tend to outperform in down markets, but will underperform when markets are rising. In other words, you sacrifice some return potential for a lower degree of risk, which is usually a desirable trade-off in a retirement plan.

If you prefer to invest directly in stocks rather than through mutual funds, the same principles apply.

Make sure your portfolio is well-diversified and concentrate on shares in companies that are market leaders.

Don’t put speculative stocks in your RRSP.

Excerpted from Gordon Pape’s 2002 Buyer’s Guide to RRSPs, to be be published in November by Prentice Hall Canada.