RRSP's And Investing Your Money

The question that I get asked most often about Registered Retirement Savings Plans (RRSP'’s) is, "Where should I invest this money?"”. This is also the hardest question because there is no one quick answer. You should first understand that an RRSP is like any other investment except that it is sheltered from income tax. For our American friends and clients, substitute IRA or 401K for RRSP (in most cases). The government approves the types of investments in the plan and then it is registered to be sheltered from tax. And beginning this year, there are no restrictions on the foreign content in your RRSP portfolio.

For more information on qualified investments for Canadians, click here.

Investing Basics
Most investment vehicles can be set up as an RRSP. If you are a sophisticated investor with plenty of time available to manage your portfolio, you might consider setting up a self directed RRSP. To do this, you must have a financial institution set it up. There is a cost to maintain it and a cost for every trade in and out of it. Add this to the brokerage costs, etc, and it can get very expensive. You had better to be able to make extra good returns on your investments to pay for these costs.

Most investors will get professionals to manage their investments for them. Basically, this is how a mutual fund works. Mutual funds are not just stocks. There are thousands of types of funds...high risk, low risk, blended, stocks, bonds, precious metals, index funds, etc. You buy shares in a fund that owns investments and manages them. For this, you are charged a management fee. All funds have them, hidden or otherwise, because nobody works for free. It'’s your job to find out what these charges are. All funds disclose them but sometimes it is stated in a way that is confusing.

In addition to management fees, many funds have a "“load"” factor. This is a charge made when you buy or sell your shares in the fund. Some funds are "no load"” so they have no charge. Most of these funds are run by large financial institutions such as banks. Other funds have a "“front end load"”, a cost when you buy the fund, or a "“back end load"”, a cost when you sell the fund. So why, you might ask, doesn'’t everyone just buy no-load funds? Often, these fund are not very good performers. Often, the "“loaded"” funds are the best in making you money. Often, they are not. No matter what the case, it is your job to do the research and fund out if a fund is making you more than they cost. Which brings us to the topic of fund performance. When you pay fee to a fund you are actually paying for the funds management.

Naturally, you want the best managers for your money. So how do you determine this? Well, the only way is to judge the funds performance over a period of time, and the longer the period of time, the better. You can then compare the fund'’s management with things like stock market indexes (for equities), and the performance of similar funds. For Canadian funds, I would suggest Globefund.com as a great source of information. For USA Investors, you might try Morningstar.com

Here'’s the Canadian link.

Here'’s the American link.

So now we get to "“what to buy?"”. Well, I'’m sorry folks but there is no one right answer. What you invest in will depend a lot on who you are and how much risk you can tolerate. Here's a few tips on how to do that.

Determining Your Risk Level
With so many different types of investments to choose from, how does an investor determine how much risk he or she can handle? Every individual is different, and it's hard to create a steadfast model applicable to everyone, but here are two important things you should consider when deciding how much risk to take:

• Time Horizon - Before you make any investment, you should always determine the amount of time you have to keep your money invested. If you have $20,000 to invest today but need it in one year for a down payment on a new house, investing the money in higher-risk stocks is not the best strategy. The riskier an investment is, the greater its volatility or price fluctuations, so if your time horizon is relatively short, you may be forced to sell your securities at a significant a loss.With a longer time horizon, investors have more time to recoup any possible losses and are therefore theoretically be more tolerant of higher risks. For example, if that $20,000 is meant for a lakeside cottage that you are planning to buy in ten years, you can invest the money into higher-risk stocks because there is be more time available to recover any losses and less likelihood of being forced to sell out of the position too early.

• Bankroll - Determining the amount of money you can stand to lose is another important factor of figuring out your risk tolerance. This might not be the most optimistic method of investing; however, it is the most realistic. By investing only money that you can afford to lose or afford to have tied up for some period of time, you won't be pressured to sell off any investments because of panic or liquidity issues.The more money you have, the more risk you are able to take and vice versa. Compare, for instance, a person who has a net worth of $50,000 to another person who has a net worth of $5,000,000. If both invest $25,000 of their net worth into securities, the person with the lower net worth will be more affected by a decline than the person with the higher net worth. Furthermore, if the investors face a liquidity issue and require cash immediately, the first investor will have to sell off the investment while the second investor can use his or her other funds.

The Investment Risk Pyramid
After deciding on how much risk isThis pyramid can be thought of as an asset allocation tool that investors can use to diversify their portfolio investments according to the risk profile of each security. The pyramid, representing the investor's portfolio, has three distinct tiers:

Base of the Pyramid - The foundation of the pyramid represents the strongest portion, which supports everything above it. This area should be comprised of investments that are low in risk and have foreseeable returns. It is the largest area and composes the bulk of your assets.

Middle Portion -– This area should be made up of medium-risk investments that offer a stable return while still allowing for capital appreciation. Although more risky than the assets creinvestment base, these investments should still be relatively safe.

Summit -– Reserved specifically for high-risk investments, this is the smallest area of the pyramid (portfolio) and should be made up of money you can lose without any serious repercussions. Furthermore, money in the summit should be fairly disposable so that you don't have to sell prematurely in instances where there are capital losses.

Personalizing the Pyramid
Not all investors are created equally. While others prefer less risk, some investors prefer even more risk than others who have a larger net worth. This diversity leads to the beauty of the investment pyramid. Those who want more risk in their portfolios can increase the size of the summit by decreasing the other two sections, and those wanting less risk can increase the size of the base.

The pyramid representing your portfolio should be customized to your risk preference.It is important for investors to understand the idea of risk and how it applies to them. Making informed investment decisions entails not only researching individual securities but also understanding your own finances and risk profile. To get an estimate of the securities suitable for certain levels of risk tolerance and to maximize returns, investors should have an idea of how much time and money they have to invest and the returns they are looking for.

ARRGHH...YOU SAY?

I can hear it now...."”This is too complicated!!"”. No, it isn'’t. If it seems like it'’s too much to think about, then you risk on relying on someone else’s priorities. This is YOUR money....YOUR retirement. Part of your investment should be time. Take the time to understand just what is going on here. You don'’t have to be an expert but you should understand the basics.

Finally, consider where you are getting your investment advice. Think about what the bias is. People like me advise clients for a fee. Our bias is to the client. You are the ones that are paying, so our duty is to you. Much of the "free advice" comes from people selling you investments. Many of these people are good, honest advisors who want to keep you as a client and will do their best to work in your best interests. But remember that they are being paid by the people who provide you with the investment. Their bias will be towards them. Listen to the advice, because it may be good, but remember where the bias is.

My next article will be on spousal RRSP'’s. Check back soon.

RRSP's - What? When? How Much?

Well here it is, 2006, and it’s time to start thinking about your income tax again. As usual, the first item up is the RRSP contribution. For those that have made a monthly contribution, good for you. Your investment will be worth more in the end than the people who only contribute once a year. However, you may want to have a look at topping up your contribution before the deadline. For the people that wait until the last minute, you have until March 1st to get it done.

Here are a few of the basics:

• money that you contribute to a Registered Retirement Savings Plan is deducted from your income before the amount of tax that you owe is calculated.

• you may contribute a maximum of 18% of your 2004 earned income to a maximum of $16,500 plus any unused contribution eligibility from 1991. (check your 2004 Notice of Assessment for the correct amount or you can call Canada Revenue Agency's T.I.P.S. line for more information). The CRA web site is in our links at the side of this page.
  

• prior to this year, you were restricted as to the amount of foreign content in your RRSP but this restriction has been lifted.

If you wish to calculate the amount you can contribute yourself, as well as find out just what qualifies as “earned income”, you can download the entire CRA (Revenue Canada) guide on pensions. You can either go to the Services page on our web site or:

click here to get it.



How Much To Contribute

Remember that you are buying an RRSP for two reasons. The primary reason is to save money for your retirement. Once purchased, your investment and it’s growth are sheltered from any income tax until it is withdrawn. Under this reason, you should probably contribute whatever you can afford. Building your “nest egg” is always a good idea. You should also try to make a monthly, rather than annual, contribution. This gives you the advantage of buying into the market at different levels plus it is easier to save it a bit at a time rather than in one big lump.

As to what to buy, I will try to cover the advantages and disadvantages of different types of investments in a separate article in the future.

The secondary reason (although for some people, the primary reason) for buying an RRSP is the tax savings. The idea is that when you take it out, you will be in a lower tax bracket than you are now. But just how much you save will depend on how much you have earned during the year.

The best tax savings are made when your income is high. Let’s examine the 2005 federal income tax rates. Provincial rate vary from province to province so I can only use the federal rates as a guide.

The first tax rate increase happens on taxable income over $35,595. The federal tax rate rises from 15% to 22% on amounts over the first $35,595. If you estimate that the provincial tax is about 50% or less of the federal amount so for the sake of this discussion, lets say that it’s 10%. Your contribution target should be to eliminate or lower any income above $35,595. At our estimated tax rate, every $1,000 that you contribute will save you $320. Naturally, if your income is higher, you will save even more. The next tax level is $71,190. Income tax on amounts over that is 26%. The provincial rates rise to about 12% so now you save $380 on every $1,000 contributed.

I won’t bother going beyond this right now, but as you can see, eliminating tax on the higher brackets is the best strategy.

In my next article, I will be discussing types on investments and the reason for spousal RRSP. Please check back and go to our web site for more information.