Three secrets to RRSP success

Over many years, it has become apparent to me that the number one reason why many RRSPs do not perform as well as investors would like is the failure to establish a well-defined strategic plan at the outset and to stick to it.

This fundamental failing was brought home to me again this week when I had the privilege of attending a small luncheon sponsored by RBC Mutual Funds at which New York money manager and best-selling author James P. O’Shaughnessy was the featured speaker. O’Shaughnessy manages three funds for RBC, all of which have done extremely well. He uses a highly-disciplined approach to stock selection, from which he never wavers no matter what the market conditions may be.

He reminded us that, at the outset, his RBC funds did not perform terribly well. They were launched just as the high-tech boom was approaching its peak. Since the overpriced tech stocks did not meet his parameters, they did not appear in his portfolios. For as long as the bubble continued, his funds lagged the field and people kept asking: “How can you not have Nortel in there?” But when the craze collapsed, his funds started to shine d the question became: “How did you manage to avoid the Nortel meltdown?”

Inconsistency an enemy of success
His simple answer: by staying the course. “The biggest enemy to success in the stock market is inconsistency,” he told the group, which was mainly composed of RBC Dominion Securities brokers. “That’s what most money managers are guilty of and it explains why so few of them beat the indexes.”

If professionals fall prey to hunches and stray off course, it is obviously much more difficult for the ordinary investor to stick to a plan. Emotion often overtakes rationality and we make decisions that deviate from the program we originally put in place.

This is especially true in RRSPs. Millions of Canadians have them and most of them are not investing experts, far from it. The fact is that you don’t have to be a genius to succeed. But you MUST have a plan.

A basic RRSP plan essentially requires three things: structure, diversity, and consistency. Let’s look at each in turn.

Structure: Decide on a basic asset mix, one that is suitable for your age and risk tolerance. For RRSPs, my advice is to adopt a conservative approach. This is your retirement money. You should not be putting it at undue risk. If you need any confirmation of that, check out the numerous stories that have appeared in the media about people who have been forced to delay their retirement because of heavy losses suffered in their RRSPs during the bear market.

Your goal should be to achieve steady growth in the plan over a long period of time and to avoid any negative years. The latter point is extremely important. If your RRSP loses 10% in a year, you will need to gain almost 12% the next year just to get back to where you started. Even if you achieve that, you will effectively have lost two years worth of investment growth.

Next page: What’s the mix?

A basic RRSP structure that offers decent growth potential for someone under age 50 while keeping risk to a reasonable level might look like this:

Cash: 5 per cent. Includes money market funds, Treasury bills, bankers’ acceptances, and Canada Savings/Premium Bonds.

Income: 45 per cent. Includes a mix of government bonds, high-grade corporate bonds, well-managed bond funds, conservative income trusts, and preferred shares rated no lower than Pfd-3.

Equities: 50 per cent. In this category, include conservatively-managed Canadian equity funds, blue-chip stocks, and some U.S. and international funds with a record of low volatility.

As you get closer to retirement, gradually reduce the equities component and add to the income component.

Diversity: One of the points that O’Shaughnessy stressed repeatedly in his presentation is the importance of portfolio diversity. “You never know what will work best in a given year,” he remarked.

The two major style divisions on the equity side are growth and value. His RBC O’Shaughnessy Canadian Equity Fund combines both in equal portions and you can’t argue with the results: a five-year average annual compound rate of return of just under 13 per cent, almost double the category average.

You can emulate this value-growth split in your own RRSP very simply. Of course, RBC and O’Shaughnessy would like you to do it simply by purchasing their funds, but there are many other choices as well.

Consistency: Once you have a plan in place, stick with it. That doesn’t mean you should never trade a security, quite the contrary. O’Shaughnessy had a 100 per cent turn-over in his U.S. Growth Fund in 2003. But all the newcomers met his fundamental parameters for stock selection.

Take a page from his book. If you decide that a particular stock or bond or mutual fund is not performing to your expectations, or has reached its target price, sell it. But make sure that the replacement security is of the same type and that your basic asset mix and style variation formula does not change.

Those are your keys to RRSP success. They may seem very simple. The hard part is staying on course.