At this time of year, Canadian investors are preoccupied with four key questions about their Registered Retirement Savings Plans (RRSPs): How much to contribute before the deadline? Would the same money be better invested in a Tax-Free Savings Account (TFSA)? Will you have enough at retirement? What should you ultimately invest your cash contribution in? These are all good questions to ask. And finding the answers is a healthy exercise to go through. But you’d better act fast, because the deadline for 2011 RRSP contributions is February 29. My quick-take answers to these questions – and a couple of recommendations – follow.
1. How much to contribute. Ideally, you should contribute your maximum allowed before the deadline, should your current personal circumstances allow for it. If not, perhaps a reassessment of your income versus expense equation is in order. The maximum allowed for anyone for 2012 is $22,970, subject to your income level in 2011 and unused contribution amounts accumulated since 1991.
2. RRSP or TFSA? I have a similar answer for the RRSP vs. TFSA “dilemma.” Both are excellent vehicles to protect you from tax in different ways, yes, but if you can do the maximum for both, this “dilemma” quickly becomes a non-question. If you can’t do both, the income versus expense analysis again may be the most prudent solution.
3. How much do you need? On having enough at retirement, I’ve always been and still am skeptical of any trite formulas, such as “70% of preretirement income” or a magic lump sum goal predicted by present-value calculations and techniques. In a vague manner, however, I do put some faith in the idea that if you contribute 18% of the previous year’s earned income every year, you probably won’t end up much worse off, relatively, than fellow citizens who do the same. From there, the differences in outcomes will likely depend more on how your contributions are invested than on how much you contribute in the first place.
4. Where to invest. So where do you invest your contribution this year? I’d like to sidestep that question for a moment to first query how you’re already invested. And by that I don’t mean just within your RRSP. Investors often look at an RRSP as a separate thing, even a physical thing, an attitude revealed by comments such as “I’m going to buy an RRSP this year.” An RRSP is nothing more than a container – one account among many where you can store your investment capital and just one part of your whole portfolio. By the same token, your spouse’s RRSP is indistinct from your own RRSP, unless things aren’t predicted to go well in the matrimonial department.
It always both amused and troubled me when, at review time, clients wanted to discuss their investment account first, then their RRSP as a separate entity, and then “after that, my wife wants to talk about her account, and then her RRSP.”
When you’re deciding where to invest this year’s RRSP contribution, don’t forget all your containers, from savings cash in the bank to GICs in a trust company to your cash and margin accounts, plus all your registered accounts such as TFSAs and RRSPs, and those of your spouse. Lump them all together and figure out your current asset allocation before deciding where to go from there.
I suspect that following this approach, most couples and individuals will find that they have relatively too much cash for their personal circumstances, constraints, and current capital market expectations, and too little in fixed-income securities, whether they qualify as safety, income, or growth investors.
My personal preference for the fixed-income asset class has always been individual bonds, but if you need to get your feet wet or beef up on your fixed income, the right exchange-traded fund (ETF) is a very efficient way to get that done.
There is a shakeup afoot in the Canadian ETF industry. How that will affect fees and variety of product offerings is too soon to tell, but that shouldn’t make you hesitate on whipping your asset allocation into optimal shape. If you need to augment your overall fixed-income holdings, you might consider the following ETF, even though you probably won’t put it in your RRSP.
BlackRock Asset Management runs the iShares brand now, and therefore is the distributor of the granddaddy of fixed-income ETFs, the iShares DEX Universe Bond ETF (TSX: XBB). It merits a Fundata FundGrade "A" rating, and deservedly so. This ETF seeks to replicate the performance of the DEX Universe Bond Index, which is to say the broad Canadian investment-grade fixed income market, including Government of Canada bonds, provincials, municipal bonds, and corporate bonds. Corporates are further diversified among industry groups from financial to energy to real estate to securitization – the index comprises about 1,000 quality bonds in total.
You can have a piece of this huge portfolio for a recent NAV of $31.28 per share, and an MER cost of 0.30%. It has no load, front or back (though expect an adviser to ask for a commission), it’s RRSP-eligible, and has over $2 billion in assets. It also currently ranks 11 out of 332 peer funds, and returns are first quartile for all periods, from one month to 10 years (6.4% compounded return), save for three years (second quartile), which captures the financial crisis. This is an investment that you probably won’t put in an RRSP, owing to its taxation.
By keeping the fixed-income ETF outside your RRSP, you might in fact free up capital inside your RRSP, including your current contribution, to invest in an equity fund such as the Dynamic Equity Income Fund, Series A, also a FundGrade A-rated fund, which I have written about in previous articles, and which I recommend again now.
These are both excellent candidates for investment, the iShares bond ETF outside an RRSP and the Dynamic equity offering inside. But getting the proper asset allocation first is paramount.
David West, CFA, FCSI, has more than 30 years’ experience in the financial services industry as an adviser, trainer, writer and commentator. He is a columnist for The MoneyLetter and Canadian Business Online among others, and is a regular contributor to the Fund Library.
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