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10 key rules for successful RRSP investing

by Wayne Cheveldayoff, 2004-02-19

For those without a great employer-sponsored pension plan, a comfortable retirement will depend on a successful RRSP strategy.

Here are 10 key rules to guide you in achieving that goal.

1. Contribute as much as possible to your RRSP early in life. A common regret among those now approaching retirement is that they did not put away enough money early on. Don’t let this happen to you. If you find you cannot contribute the maximum to your RRSP and buy a house, postpone buying the house for a few years. Those with homes know how ongoing maintenance and repair costs can chew up funds and frustrate savings goals.
2. Leverage the power of compounding of investment returns within your RRSP. An initial sum of $10,000 will grow into a lot more at a 7 per cent return compounded over 35 years than it will at a 5 per cent return. Work to get the extra return you need.
3. Contribute as early as possible in the year. By waiting until the last minute, you are giving up tax-sheltered investment returns (for as much as 14 months) that can compound into a sizeable sum over the years.
4. For salaried employees, request a reduction of income tax deducted at source for the contributions that you are making into your RRSP. This way more money will be in your RRSP earning a return sooner than if you wait until February each year to make an RRSP contribution and April to get a tax refund on the contribution. If you do reduce income tax deducted at source, make sure you make the right amount of RRSP contributions or you will be hit with a tax bill later on.
5. Take advantage of tax strategies associated with RRSPs. If you have investments inside and outside an RRSP, it is usually best to have fixed income investments such as bonds and fully taxable income trusts inside an RRSP and capital gain and dividend-generating investments (which are taxed at a lower rate) outside an RRSP. Also, though not always the case, it may make sense to utilize spousal RRSPs for effective tax-splitting in the future.
6. If you are short of funds to maximize this year’s RRSP contribution by the March 1 deadline, consider borrowing to do so. However, only borrow an amount that you can repay within one year. Borrowing may also be a good disciplined way to contribute if you find it hard to save in any other way. But it is not an efficient strategy, given that interest paid on RRSP loans is not tax deductible.
7. Diversify your RRSP portfolio in the same way as large pension funds, which normally spread the investments into stocks, bonds, hedge funds, income trusts, real estate and so on. Also, consider splitting equity exposure by style of management, such as value, growth, momentum and small cap. Such diversification lowers risk while maintaining a reasonable rate of return over time.
8. Make use of the different techniques for boosting foreign content in your RRSP above the 30-per-cent limit set by the government. Canadian stocks account for only 3 per cent of world stock markets. By sticking with only Canada, you are missing out on a lot of opportunities, especially in the high-growth technology and pharmaceutical industries that are concentrated in the United States. A major risk associated with foreign investing is a sharp increase in the Canadian dollar, which diminishes the value of the foreign holdings. This has already occurred, so it is a good time to increase your foreign exposure. Consider moving foreign content to 50 per cent or more using a “clone” fund that mimics the return of a foreign mutual fund, or an RRSP-eligible international index fund that mimics the return of a foreign stock index like the S&P 500.
9. Pay attention to fees, as the more you save on fees without sacrificing return, the more you will have in retirement. If you want broad exposure to the stock market, consider using an index fund with a management expense ratio (MER) of 0.5 per cent versus an equity mutual fund with an MER of 2.5 per cent. For exposure to bonds, consider investing directly in bonds rather than paying MERs of 1.5 to 2.5 per cent for bond mutual funds. Stay away from balanced funds where the bond component, like the equity component, is subject to a MER of 2.5 per cent.
10. Resist taking funds out of your RRSP except for dire emergencies. First, once removed, the money is not earning a tax-free investment return that you will need in retirement. Second, you have given up valuable RRSP contribution room. Third, the money taken out is taxed as regular income. With interest rates low, it may make more sense to borrow for the emergency if you can. Also, while you can take out limited amounts temporarily without being taxed for the purchase of a home or for education expenses, it may not be the smart thing to do. You need to weigh the consequences of that money not earning a return in the RRSP for several years until you pay it back.

In setting up your RRSP strategy, be sure to consult all available books and other sources of information. Most people would benefit from using an investment advisor. However, you must ensure the investment advisor is right for you.

Some investment advisors or financial planners can offer only mutual funds and GICs. This doesn’t necessarily work for your benefit, since it means you are missing out on opportunities like direct investing in bonds, stocks and income trusts.

Like in every other market, it is buyer beware when making investments. Those that don’t educate themselves and ask a lot of questions are more likely to miss opportunities or be taken advantage of.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.


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©2004 Wayne Cheveldayoff