Friday, March 21, 2008

7 Tips for RRSP Contribution

Have a plan: It is all too common that Canadians invest in "something" when they scramble to make their RRSP contribution before the deadline. Often, the "something" is an investment recommendation from an advisor that unfortunately results in a potpourri of holdings that turn out to be yesterday's winners. This year, when investing your contribution make sure that you have a well-defined asset allocation strategy and refuse to invest until you or your advisor comes up with one

Park your contribution in a money market fund: A RRSP allows you to hold cash but while you wait to develop an investment strategy, invest the contribution in money market funds or cashable GICs. That way, you have the access to cash when you are ready to actually invest but you are earning something on your funds in the meantime.

Ignore the ads: When money managers take out ads showing the excellent past performance of some of their mutual funds, you should remember that a) investors don't get to earn past performance b) there is no correlation between past performance and future results and c) when retail investors jump on a trend, it is already too late to ride that train. So, this RRSP season, just ignore the glitzy ads and the drooling returns so prominently displayed.

Check out low-fee options: Canadian mutual funds are notoriously expensive. The average MER of a Canadian equity fund is close to 2.5%. The math is simple - the higher the fees, the lower your returns. Fortunately, low-fee funds are available from many boutique money managers whose fees are substantially lower at 1.2% to 1.8%. By paying lower fees, your chances of earning higher returns than average increase substantially.

Don't hold too many funds: Many investors are under the mistaken impression that the more funds they hold, the better diversified they are. A handful of funds representing different asset classes will provide you with all the diversification you need.

Consider indexing: Index funds simply track a popular index such as the TSX Composite or the S&P 500. Index mutual funds or Exchange-Traded Funds that can be bought and sold like a stock have the following advantages: a) low fees b) tax efficient because their turnover is typically very low c) since the vast majority of funds fail to beat their benchmarks, an index fund is likely to provide you with higher returns.

Tread warily among these investments: In my opinion, it is best to stay away from these investments: principal-protected notes, labour-sponsored venture capital funds, funds that invest in narrow sectors such as biotechnology or energy or materials, funds that invest in narrow geographic areas such as China or India, mutual fund wraps etc.