Week 7 - RRSPs Part 2

I'm settled in. It's Wednesday night. There's a Raptor game on TV, which is going well. Life's good! Then, someone comes in and wants to watch Cougar Town. Time to post week 7.

Last week, I talked about the benefits of RRSP contributions and went over some strategies to maximize your total return down the road. We looked at the power of compounding rates of return, while being able to defer the taxes until we actually need the money.

This week, I wanted to go over a couple of ideas for how your RRSP could be set up, if you are someone that hasn't found the right advisor to work with yet.

We talked about mutual funds already, which are great investment vehicles if you don't have the expertise to pick stocks. I actually prefer picking stocks - I like the research, following my picks, making changes and trying to maximize returns for me and my clients. I would recommend that my clients do the same, or at least let me do it for them! I truly believe that I can achieve better returns this way, if for no other reason than the fees aren't nearly as much when you buy and sell stocks directly.

If you haven't found the right person to work with yet but still need some advice as to how to set up your RRSP, consider this step by step mutual fund strategy:

1) Look for 4 mutual funds, one in each of the following asset categories;

a) Canadian Equity

b) Canadian Bond/Income

c) Global Equity

d) Emerging Markets Equity

When considering your options, look for funds with good long-term returns (see if their 5-year return is good enough to get a 5-star rating) and look for fund managers that have been working on the fund for a long time.

2) Divide your RRSP equally among the 4 funds.

3) Each year, when you make your new RRSP contribution, add to the funds so that they rebalance back to their 25% weight per fund. Make sense?

Essentially, you are adding to the funds that have underperformed, while taking away (or not adding new money) from the funds that have outperformed. It's an easy way of staying disciplined, even if it's been a bad market for one of the areas. It takes the emotion out of having to make the picks yourself. I'd say this is a great strategy for anyone more than 10 years away from retirement.

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If you are closer than 10 years to retirement, congratulations! That said, it probably doesn't make sense to have 75% of your money invested in equity funds (which could decline in value and leave you needing to wait longer for retirement), especially since most mutual funds don't pay a consistent income. With stocks, you can sometimes keep a high weighting because they often pay dividends that will help support your retirement lifestyle, while still offering the potential for future growth. It's different for everyone, depending on your personal situation.

If you aren't in stocks and want a simple rule, consider the old adage that you should always have your the same percentage as your age invested in bonds. So, if you are 50 years old, then you should be 50% invested in bonds or other fixed income investments. As you get older, you can shift more money into bonds to preserve your capital and increase your income. The only problem with this is that right now, bonds pay a very low income. If you were invested in 10-year bonds right now, your average annual return would probably be about 4%. Yes, some bonds pay better rates but aren't of the same quality as the ones that pay lower rates. You want higher returns? Be prepared to take on more risk. Either way, it's a good starting point for someone looking for very basic guidance on setting up an RRSP asset allocation. Just remember the part about rebalancing every year.

Some of you probably have more than 4 funds in your portfolio already. You don't need them. Just pick 4 funds that have good track records. Between all 4 funds, you will likely have about 200 stocks and bonds, which is more than enough diversification. The only reason you should ever switch out of one of the funds completely is if the manager changes. In that case, all bets on past performance are off.

With a stock portfolio, I would only have up to about 20 stocks and then add bonds as needed. I think this is enough diversification, provided my clients are prepared for the ups and downs of owning stocks.

Another thing to consider is that if you have an RRSP and a non-registered account, keep the stocks in the non-registered account and keep the bonds in the RRSP. The interest created by the bonds is taxed at regular income levels, while dividends and capital gains are taxed at approximately half that rate.

The bottom line is that investments in an RRSP are probably a lot easier than many people would have you believe. I think that if you follow that simple formula, you will be satisfied over the long term. You will also be able to brag to your friends that you actually had the balls to add to your equity funds in years like we had in 2008 and 2009, which is a move that would have nicely paid off if you had done so.

Thanks again for reading. Next week, I will continue with RRSPs for those of you who are left wanting more.

Cheers.