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Top 10 Dos and Doníts in RRSP Investing

by Wayne Cheveldayoff, 2006-02-02

Here are 10 guiding principles in RRSP investing that will help you achieve your ultimate goal of having enough money for a comfortable retirement.

1. Donít pay fees unnecessarily unless you are getting good value for your money. Fees drag down returns, so you definitely want to minimize that unless you are getting something useful in return. Not all advisors will volunteer what the fees are, so be ready to ask for a full explanation. Youíll also have to judge if the fees are worth it. A prime example is a bond fund holding government bonds and charging a management expense ratio (MER) of 2 to 2.5 per cent a year Ė thus chewing up half or more of the expected return. Similarly, it doesnít make much sense to own a balanced fund where the usual 2.5-per-cent-plus MER is applied to the bond and cash components as well as the equity component. Paying that much for a pure equity fund may be worth it but you should try to invest directly in government bonds or at least in a low-fee bond fund, such as one of the iUnit bond exchange traded funds (ETFs) that charge an annual MER of less than 0.5 per cent.

2. Do your homework. Research investment alternatives or use an investment advisor to achieve the highest possible longer-run returns. An initial sum of $10,000 will grow into a lot more at a 7-per-cent return compounded over 30 years than it will at a 5-per-cent return. If you doubt it, check this on one of the free RRSP calculators located at a bank or mutual fund website or at www.investorED.ca.

3. Donít take funds out of your RRSP unless you are in a dire emergency. Not only will the withdrawal be fully taxed as income, you will miss out on the tax-free compounding of your nest-egg. With interest rates low, it may make more sense to borrow the money you need. Even for tax-free sums taken out for education or a house purchase, there will still be a drag on RRSP growth since they will earn no return until they are paid back.

4. Donít borrow to contribute into your RRSP unless you are sure you can easily pay the money back within a year. Interest on such borrowings is not tax-deductible. While some people canít bring themselves to save unless they are paying back a loan, it would be wiser instead to adjust your budget and start up and stick with a Ďpay yourselfí regular monthly contribution plan. The sooner you start, the more youíll have in retirement.

5. Do contribute to an RRSP as early in the year as possible. By waiting until the last minute, you are giving up tax-sheltered investment returns that can compound into a sizeable amount over the years.

6. Donít ignore the income-splitting benefits of contributing to a spousal RRSP. Depending on your situation, it may lower your tax rate when you and your spouse ultimately withdraw the funds to pay for your retirement.

7. Donít forget to diversify your RRSP investments. Large pension funds spread out investments among stocks, bonds, and income trusts. They also use hedge funds but such investments are not easily accessible for most Canadians except through principal-protected notes.

8. Do make use of international investments. Diversification lowers risk while maintaining or increasing returns over time. By sticking only with Canada, you are missing out on potentially greater opportunities. Canada has few world-class companies, especially in technology and pharmaceuticals, which can dominate their markets and thereby profitably reap the rewards.

9. Donít make the mistake of thinking that trust is enough when dealing with any financial institution or investment advisor. Yes, you need to feel you can trust, but you also need to verify. Particularly when you are unsure about an investment product or the advice you are getting, ask for things in writing and read the fine print.

10. Donít drift or procrastinate when it comes to contributing to an RRSP or managing the investment. Itís not going to happen by itself. The problem wonít go away if you ignore it. You need to take action and be decisive. Make the time. Seek whatever help you need. Itís your money and your life in retirement.

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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©2006 Wayne Cheveldayoff