It's RRSP season, but don't panic
Yes, it's RRSP season and high time to consider reducing this year's tax bill. If you are like most Canadians then you'll deal with your RRSP at the last possible moment. Unfortunately, making rushed RRSP decisions can be dangerous. For instance, it is important to avoid buying securities that lock you in for a long time such as mutual funds with deferred sales charges. Similarly, trying to figure out which stocks to buy at the last minute is a recipe for disaster. Instead, RRSP investors should take Warren Buffett's advice to heart and remember that "The stock market is a no-called-strike game. You don't have to swing at everything -- you can wait for your pitch.". In the end, it is better to take the time to make good investment decisions.
To avoid the last minute RRSP panic, simply put new money into high-yielding short-term debt. Good old GICs, high-interest savings accounts and treasury bills are all possibilities. Fund investors should consider the PH&N Canadian Money Market Fund or the Perigee T-Plus Fund. Both funds have superior track records due to able management and low fee structures.
Keep in mind that there is a price to be paid for waiting in short-term bonds. Short-term bonds generally yield less than long-term bonds and inflation can errode your returns. For instance, if your GIC pays 2% but inflation comes in at 3% then, at the end of the day, your effective buying power is reduced by about 1%. Look at it this way, a year of 2% gains turns $100 into $102. However, if inflation is 3% during the same period then a $100 Christmas goose turns into a $103 expense. You would have to pony up an extra $1 to buy a similar goose next year. As a result, short-term bonds are a good place to store money until you can take the time to consider more complicated investments.
Once you've dealt with this year's RRSP contribution then you'll have the luxury to plan for the long-term. When it comes to long-term planning it is important to formulate a personal investment policy. Many investors don't have an investment policy which is a shame because it is a valuable tool that can save a lot of money. An investment policy starts out by describing an investor's financial situation, goals, constraints, and risk tolerance. It then moves on to formulate an investment strategy that can accomplish these goals. Investment policy is all about big-picture planning and strategy. Most importantly, a written policy statement is a useful guide for both investors and advisors. With a good policy in place, investors will know what to expect from their advisors and advisors will know how to best help their clients.
Risk management is the cornerstone of any investment policy. Until recently, most investors have been far too willing to accept extra risks in an attempt to earn higher returns. Often the idea has been to simply dial up risk tolerance until the desired level of return is achieved. In my view, such an approach to risk management is dangerous. However, a low tolerance for risk may mean that the investor is unlikely to achieve their stated goals. In these circumstances, the goals should be changed and not the investor's tolerance for risk. If an investor is of modest means then retiring in luxury is probably out of the question. Far too many investors pressure their advisors to make their unrealistic dreams come true. As a result, they load up on risky securities which may lead to success but are much more likely to lead to ruin. Proper risk management is all about defense.
When it comes to developing an investment policy, most advisors will try to help, but few are good at it. Developing an investment policy requires expertise that the majority of advisors lack. As a result, it is a good idea to seek out more experienced advisors who specialize in investment policy and planning. For the die-hard do-it-yourself investor, Charles Ellis' book Winning The Loser's Game (ISBN 0070220107) discusses investment policy development in some detail. Once you have a good investment policy then it is a relatively simple matter to move your RRSP from short-term debt to more sensible long-term investments that fit in well with your long-term goals.
Finally, there is no reason to make rushed decisions when it comes to your RRSP. To avoid last minute RRSP pressure simply follow the RRSP three step; buy short-term debt, consult your investment policy, and wait to buy the right securities for your portfolio. You may have to hurry to make this year's RRSP contribution but you should take the time to find great investments.
First published in February 2003.
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