Protecting RRSP savings

I’ve been giving a lot of thought lately to the question of how Canadians can protect the savings they tuck away in their RRSPs. It’s an issue that has been nagging at me ever since the market meltdown of 2008-09 which, based on anecdotal evidence, hit many RRSPs extremely hard. But it was brought to the front burner when I received an invitation to appear before the Senate Committee on Banking, Trade and Commerce which is looking into the subject of retirement savings as it relates to RRSPs and Tax-Free Savings Accounts (TFSAs).

This is all part of a widespread government review of Canada’s retirement planning system. The mandate of the Senate Committee is fairly narrow in that it does not specifically include pension plans (although that doesn’t stop some senators from questioning witnesses about them). Among the specific issues the senators have been asked to consider is how to protect the savings within RRSPs and TFSAs.

Here’s my idea: create a system for pooling RRSPs and have the money managed by professionals, such as the Canada Pension Plan Investment Board (CPPIB).

Every study I have seen suggests that the majority of people who use a financial advisor get better results than those who take the do-it-yourself approach. It also appears from the surveys that most people who have an advisor are satisfied with the service and the results. However, there are exceptions and I have received many e-mails from people who are unhappy with the way their money is being handled.

One of the problems facing every financial advisor who sells products is an inherent conflict of interest situation. It boils down to the fact that what is best for the client is not always the most lucrative course for the advisor. For example, most mutual funds pay trailer fees to advisors. These are annual payments which are supposedly for services rendered to clients. But they also constitute a strong financial incentive to encourage advisors not to move clients into other types of securities.

To illustrate, suppose you buy units of a Fidelity equity or balanced fund through your advisor. Unless you have a fee-based account, you might have to pay a sales commission on the purchase, depending on the type of units you buy and your broker’s policies. But that’s not the end of it. If you buy front-end load units, Fidelity pays the dealer an annual one per cent trailer fee, based on the total value of your assets in that fund. When you spread that over many clients it adds up to a lot of money. If a dealer has $10 million worth of Fidelity equity and balanced funds in his “book”, that’s worth a cool $100,000 annually. DSC units carry a lower trailer, at 0.5 per cent, but the up-front commission paid by Fidelity to the dealer is higher.

However, if you buy a money market or fixed-income fund instead, the trailer fee is only 0.25 per cent. That’s a big incentive for an advisor to encourage you to buy equity or balanced funds. It is also a reason for the advisor to discourage you from switching out of mutual funds into, for example, ETFs. Most advisors understand that in the long term the financial well-being of their clients will provide the best return to them. But the potential conflict will remain as long as the current system exists.

(Note that I have used Fidelity only as an example; most mutual fund companies operate the same way.)

By creating a public entity to manage pooled RRSP money (or assigning the task to the CPPIB) we could remove this conflict of interest and ensure that Canadians receive the best possible professional money management plus access to securities they can’t buy as individuals. Over the decade ending Dec. 31, 2009 the CPPIB achieved an average annual compound rate of return of 5.61 per cent on the assets it managed on our behalf. When you consider we had two major market crashes during that time, that’s an excellent. I suspect that most Canadians did not do as well in their RRSPs.

The cost would be offset by an annual fee charged to the RRSP pool which would certainly be much less than people are paying now in terms of sales commissions, mutual fund management fees, and other expenses. The system would be optional; people could continue to use their own advisor or manage the money themselves if they prefer. But I think a large percentage of Canadians would choose to opt in to such a plan.

Of course, financial institutions would oppose this idea because it would potentially mean the loss of significant wealth management business. So I acknowledge this proposal could be political dynamite. But the fact is that the current situation is not satisfactory. Most people are simply not well-equipped to make the best investment decisions. In some ways, it’s akin to tossing a child into a pool and hoping he or she will instinctively figure out how to swim before drowning.

The reality is that most people need help in managing their retirement savings. The private sector offers such assistance but unless we reform the compensation system there is always a danger that some advisors may succumb to the temptation of recommending securities which are the most profitable for them.

I believe a low-cost public alternative is a viable option. We already have a model in the CPPIB. Let’s build on it.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about a three-month trial membership go here.