Remember 2015? It was certainly an eventful year.
- Adele released “Hello”
- All-day breakfast at McDonald’s became a reality
- Picture of a dress went viral (it was actually black and blue)
- A chicken had started tweeting
- Adult colouring books finally caught on
Oh I almost forgot: 5,989,810 Canadians made RRSP contributions in 2015, with the median annual contribution being $3,000.
As much as I enjoy Sausage ‘n Egg McMuffin, impromptu color blindness test, cute chicken, belting out to pop ballads, and colouring outside the lines, that last piece of info interests me the most.
So let’s continue talking about RRSPs, shall we?
Jokes aside, RRSPs are pretty damn awesome.
Let me count the ways:
- You could save for a comfortable retirement by investing in a wide range of financial products inside your RRSP
- The Home Buyers’ Plan lets first-time homebuyers withdraw up to $25,000 to be used as down payment
- The Lifelong Learning Plan lets students withdraw up to $20,000 to finance their full-time education
- RRSP contributions are tax-deductible
- Investment gains inside an RRSP are tax-deferred
- You can carry forward unused contribution room indefinitely
Real talk: you probably don’t need someone to hype up RRSP for you. You’re here to find out one thing and one thing only: how can you optimize your RRSP to make it work harder for you?
Here are my top RRSP tips for you:
Diversify, Diversify, Diversify
If you’ve ever been to the casino, you know not to bet all your chips on a single number in roulette. Instead, you spread your chips around, giving yourself more chances to win and mitigating the risk of losing everything at once.
The same diversification technique applies to investing as well – you wouldn’t want to hold a single stock in your RRSP and nothing else. Even the most awesome wide-moat stocks aren’t shielded from the impacts of rising inflation, political instability, and force majeure.
So how do you keep your RRSP account well-diversified?
Diversify among asset classes: You could hold any combinations of stocks (riskier) and bonds (safer) in your RRSP. The specific allocation of each depends on your risk tolerance. Generally speaking, bonds should occupy a larger percentage of your portfolio the closer you are to retirement age.
Diversify among different sectors: If 50% of your portfolio consists of utilities stocks, then it would be particularly vulnerable to interest rate hikes.
The Global Industry Classification Standard (GICS) divides the economy into 10 sectors:
- Information Technology
- Telecommunication Services
- Consumer Discretionary
- Consumer Staples
- Health Care
A well-diversified RRSP would hold at least one or two stocks from each sector.
Better yet, purchase already diversified low-cost ETFs.
Google “[any ETF ticker] + sector weighting” to find out an ETF’s exposure to the different sectors.
Geo-diversification: By exposing ourselves to opportunities outside of North America, we could leverage growth opportunities in the global markets. ETFs with international exposure would be great for this purpose.
Income vs. value vs. growth stocks: This is a personal preference rather than general best practice. I personally like to hold a mix of income, value and growth stocks because they serve different purposes.
Growth stocks: growth companies are ones that have the potential to skyrocket within a short period of time. They tend to be newer, more innovative (usually disrupting an industry) and focusing on expansion rather than profit. The endgame: massive returns on capital.
Value stocks: value stocks represent companies that are (often temporarily) undervalued for whatever reason. The endgame: swoop in and purchase stocks when they’re on sale in anticipation of prices returning to previous higher levels.
Income stocks: Income stocks might not appreciate much, but their dividend yields usually eclipse those of GICs and CDs. The endgame: compounding dividends.
Wouldn’t it be nice to see a certain percentage of your portfolio appreciate rapidly while the remaining assets bring ongoing cash flow?
Keep Your Fees Low
Fees eat into your RRSP’s gross returns, so minimizing fees maximizes long-term investment performance.
While you usually can’t get around paying trade commissions, other fees can be avoided.
If you hold mutual funds, you’re paying for Management Expense Ratio (MER) which could easily carve off 2% of each year’s gains. Considering that mutual funds underperform the S&P 500 over the long haul, 2% is a big price to pay for mediocre performance.
That’s why low-cost ETFs are so popular these days. Not only do they cost less (the average expense ratio is 0.44% compared to mutual funds’ 2.35% average MER), they can be traded like stocks, making them much more accessible to everyday investors.
In my mid-20s, I made the silly mistake of believing that the main benefit of RRSP lies in the tax deduction. As long as I contribute the maximum amount by the deadline, it would be all good. Back then, I would contribute $250 each month, and then make a huge contribution during the “RRSP season”.
In hindsight, it wasn’t ideal to wait until the last minute. I missed out on a full year of compounding gains, not to mention that it was tough to come up with all the cash at once.
Don’t make the same mistake I did.
If you could, make your contributions as soon as possible and let the power of the compound effect kick in earlier. This is a simple way to help your investment dollars go further over the long run.
You might be thinking: I wish I could make early RRSP contributions every year, but I just couldn’t swing it given my budget.
No problem, try the dollar-cost averaging method instead.
Using the dollar-cost averaging technique, you would contribute a fixed amount into your RRSP each month, and buy the same amounts of investments each month, regardless of prices.
Here’s how it works in practice:
Let’s say your contribution limit for 2018 is $5,000, which means you could contribute $416 per month over 12 months (I’m assuming that contributions made in the first 60 days of the year are always claimed in the previous tax year).
You decide to only hold 2 ETFs: XIC and VYMI.
Using the dollar-cost averaging method, you purchase $208 worth of XIC and $208 worth of VYMI every single month.
The results? More shares of XIC and VYMI would be purchased when prices are low, and vice versa.
The best part: You never ever need to speculate or stress over whether the market is bullish or bearish. You could just relax and watch your money grow over time. That, to me, is priceless.
- Automate your monthly RRSP contributions
- Make sure to use a discount brokerage like Questrade that allows retail investors to invest in ETFs commission-free
Borrow to Maximize Your Contribution
If all else fails and you are a high income earner, it wouldn’t be the worst thing in the world to borrow money to maximize your annual RRSP contributions ― in some cases.
As a high income earner in a high tax bracket, tax minimization strategy is more important to you.
Whatever amount you decide to contribute to your RRSP will be deducted from your taxable income, thus lowering the tax you have to pay. Therefore, you have extra incentive to maximize your RRSP contributions.
Let me clarify that this is not a suitable strategy for all high earners, because it largely depends on:
- The interest rate on your loan
- Your ability to repay the loan and interest swiftly
- If your RRSP is earning a good rate of return
- Your tax deductions
- Your investment horizon
If you’re investing for the long haul, able to secure a loan with interest rate lower than your RRSP’s rate of return, can confidently pay it back quickly, and the extra tax deduction justifies the borrowing, then MAYBE you should consider it.
Be conservative. Please consult a financial advisor before proceeding with this strategy.
For most Canadians, RRSP might be the single most important element of their retirement planning strategy.
As such, if we could get the most out of our hard-earned money by applying a few simple RRSP investing tips, wouldn’t it be great?
To summarize, keep your RRSP holdings diversified, contribute early or regularly, keep your fees low, and only when it’s necessary, borrow to invest.