The RRSP Season has already started and while most financial advisors are still thinking about their Holidays, some others are calling their clients to book appointments. So you might (or might not!) get a call this week to make your RRSP contribution in the days ahead. Regardless if you are dealing with a good financial advisor or not, you should definitely start investing for your retirement as soon as possible.

Since you don’t have access to track investment apps or high quality investment services, you need to do your own research before you meet with a financial advisor.  This is why it is so important to prepare for your meeting beforehand so you can have an idea how you want to invest your RRSP contribution. In this article, I have listed a few 2010 RRSP investment ideas that you can discuss with your financial advisor. Please note that those are not recommendations but simply investment ideas to help start the discussion.

2010 RRSP Investment Ideas:

#1 Diversified Mutual Funds

If you are a beginner investor and you are looking for your first RRSP contribution, I suggest you go with a “packaged” investment product created by your financial institution. While the management fees (that are being taken off the top of your investment returns (profits or losses) are higher than other types of investment solutions, this is a great place to start in the investing world.

Diversified mutual funds will allow you to invest in several types of assets (money market, government and corporate bonds, Canadian, American and International stock markets) and will always remain invested according to your risk tolerance, investment horizon and specific goals.

#2 Build Your Own Mutual Funds Portfolio

If you know more about the stock market and you want to pick specific funds, you can build your own mutual funds portfolio. While I don’t think it is a great idea for most investors (many think that they can manage on their own but it is usually a big mistake), you can go on investing sites (see my articles about 9 free Canadian Investing websites for links) and pick the best performing mutual funds. Make sure to pick funds that have a long track record, relatively low management fees (MERs), that are part of the 1^st or 2^nd quartile over 5 years + and that the management team has been in place for a while (you can look at the reasons to sell a mutual funds in this article).

When building your own portfolio, you must be careful about front end and back end fees (fees when you buy or when you sell). You might want to build your portfolio with a financial advisor in order to make sure you make the right decisions. Another important thing is to rebalance your investment according to your original asset allocation. While the diversified mutual funds do it automatically every 6 months, you will have to transact by yourself in a homemade portfolio. So building your own portfolio might not be a bad investment idea but it surely requires more knowledge and more time. A humble person once said that the more they know about the markets is proof that he does know much.

#3 Want To Work With ETFs?

If you are a beginner in the world of ETFs and you have a decent amount to invest (more than $25,000), you should try to contact a broker. The problem is that you may have a hard time finding one if you are just starting to invest. They are usually go after bigger accounts (this is too bad, but it is the name of the game).

If you still want to trade ETFs nonetheless, I suggest you open a brokerage account (for example Quest Trade since they have one of the least expensive transaction fees) and start with market index ETFs (ETFs replicating the Canadian Stock Market or the US Stock Market). As a beginner investor, I would not go this route but if you have been investing for a few years, it might be the right time for you to look at this option.

#4 Looking for the Best Sectors for 2010

For this investment idea, we are entering the world of speculation. Nobody knows which sector will outperform the stock market index this year. From 2003 to early 2008, the financials, resources and emerging market were pushing investors to the highest yields they might have ever seen. Yet, these went down dramatically during the credit crunch. This is why it is very risky to predict the future.

Nonetheless, you can find specialized mutual funds and ETFs concentrated by industries. The easiest way to find them is by using sites such as Morningstar or GlobeInvestor (then again, I suggest you take a look at my article about free investing websites for more options).

Trading ETFs will reduce your investing fees to the minimum but you will follow the major trend of a specific industry. On the other side, specialized mutual funds are pretty expensive in term of MERs but you can benefit from the experience of professionals. In niche sectors, I think it is easier to beat the market since the number of companies to follow is smaller.

#5 Forget about CD’s and Beware of Bonds

Certificates of Deposit will barely cover for the upcoming increase in inflation and you won’t do much with your investment with a return of 1 to 2%.

On the other hand, bonds could be a better investment idea but prepare yourself to experience a drop in the value of your bond portfolio in 2010-2011. Bonds values go down when interest rates go up, therefore, you will see a temporary drop in your investment values if you hold bonds. However, this will come back to normal at maturity (you still get your money back at the end ).

#6 Linked Notes and Variable CDs

If you are looking for more investment returns but you are not willing to see your investment yield goes negative, linked notes and variable certificates of deposit might be a great investment idea. As I mentioned before, I don’t really like linked notes because you pay a high price for your capital security. However, sometimes the peace of mind is more important that making money. And this is why banks offer the possibility of guaranteeing your investments while expecting higher yield since your investment is linked to the stock market. This would not be my first choice but it is definitely the best alternative to classic certificates of deposit.

Whoa! I usually don’t write posts this long but I thought it was important to provide some RRSP investment ideas before the madness starts in February!

What about you?

What will be your investment choice for this RRSP season? Will you stick to your plan? Change your investment picks?

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It is the RRSP season in Canada (Your last chance to contribute to your registered retirement saving plan for the year 2008 on March 2^nd), and we see a lot of government bonds advertisements. They offer bonds at about 3% interest rate and they tell you that it’s 100% and suggest that you put them into your RRSP account.

The thing is that 3% seems a lot more than your balance portfolio that did -20%, right? Many investors have the bad habit of doing linear assumption. “At a rate of -20% per year, I’ll lose all my money within the next 5 years”. Even though this assumption is mathematically wrong (as you will lose 20% of the balance of your funds each year and not 20% of you original amount), it is even more wrong to think that we will make -20% for 5 years.

To these clients, I ask them the following question:

The price of gas was at $1.50 a litre back in July 2008, 6 months later, it now around $0.80. At this rate, don’t you think that next summer we will pay $0.25 a litre?

They all think I’m stupid, however, if their linear assumption is good for the stock market, it should be good everywhere, right?

Back to our dear Government. So they offer bonds with cheap yield (I can’t blame them on that since we are living in a world of very low interest rate) and they tell you it’s good to include this in your retirement account.

Let’s do the math for fun… $5,000 per year at 3% in… 25 years. That makes a total contribution of $125,000 (5K times 25 years). Your portfolio will worth $182K. How much do you think you will be able to withdraw from it for 20 years?…. not much!

If you do the same exercise with a yield of 5%, you will get 238K and with a 7% yield (if you are aggressive); 316K. This is what we call the power of compounding interest.

I’m not saying that government bonds are not a good investment options, but depending on your age and the number of years you have before retiring, you should consider other option.

How would you react when the market comes back with a +20% in a year? How would you feel with your 3% return? If you think that you will still be happy with it, then the government bonds are a good investment option… if you swear that you won’t go back into the market after it came back from the dead!

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Dring… Dring…

- Hello, may I speak with M. TFB please.

- Yeah that’s me!

- Hello sir, my name is Evil Banker and I would like to book an appointment with you for your RRSP contribution.

- Nah… I don’t have money left for retirement this year (I just bought a brand new TV instead ).

- Well sir, we still have a solution for you. How about getting your RRSP contribution done and a retirement plan (i.e. excel spreadsheet with a graph) at the same time? We can arrange everything for a small amount per month and you would get a huge tax return in May. How does that sound?

How does that sound? That sounds like the regular banker sales pitch during a RRSP campaign I’m making fun of my colleague here but we need a bit of laughter in this strange world, don’t we?

Seriously, several Canadians contract a RRSP loan every year in order to catch up with their unused RRSP contribution. Is it a good idea? Should we use this leverage strategy? (yes, it is a leverage strategy as the Smith Manoeuvre).

The RRSP loan is a great investing strategy under the following guidelines:

- It must be at a very low rate of interest (prime rate or near prime rate)

- It must be reimbursed within a maximum of 24 months (2 years).

- It must fit in your budget

- The tax return should be used to pay off a part of the RRSP loan and not to finance the next trip to Disney Land with your kids.

- Once paid off, you should keep your payment into a saving habit by setting up a systematic contribution into your RRSP account.

- Use the RRSP loan while participating to a HBP (Home Buyer Plan)

A RRSP loan is not a great investing strategy under if the following happens:

- You take a huge amount and you can’t pay it off within 24 months. In this situation, you rather simply use the payment as a systematic contribution into your RRSP account and you will save the interest (which is not tax deductible).

- You can barely make your payments and the RRSP loan jeopardize your financial situation.

- You have no intention to use your tax return in a financial planning strategy (you are then missing the whole point of taking a RRSP loan).

So if you are not 100% convinced that you should take a RRSP loan or not, ask your financial adviser questions in order to understand if there is a strategy behind the loan or simply your banker’s commission

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Linked notes in your RRSP?

I am personally not a big fan of linked notes (you can read more on the topic here). However, it has some advantages if you have been roughed by the markets lately. If you do not consider investing in mutual funds, indexes or other product related to the market due to their volatility, you might like linked notes. They guarantee your capital 100% and offer a yield related to the market. They are usually offered for 3 year and older (up to 8 years). Since this is an investment for your retirement, you don’t really have to worry about the investment term.

Cut the fees in your RRSP account

If you are young and still accumulating on a monthly basis, this strategy might be difficult to apply. However, if you have more than 100K invested in your RRSP account, you will love this strategy.

Instead of paying fees to have your fixed income managed you can do it yourself or having your financial planner / broker do it for you for 0% MER’s! By doing a bond ladder will avoid unnecessary fees on something that will give you only 4 to 5% yield anyway. So separate your RRSP account into 2 part according to your original asset allocation: a part with 0% MER’s with a bond ladder and the other part fully invested in the markets (Canadian, American and international markets).

Get a rrsp loan to catch up unused contributions.

This is an easy and simple way to boost your RRSP: force yourself into a periodic investment You will have to do it backward and contract a loan to create the saving habits you it is better now than never

Once your rrsp loan is reimbursed, keep the same amount and invest it directly into your RRSP’s. Therefore, you won’t have worry about your RRSP contribution and retirement. You will be set on semi automatic pilot

What is your RRSP strategy for 2009? Are you going into index funds? Directly into ETF’s? GIC’s and corporate bonds?

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Assumptions

So here are the numbers I worked with: You can save up to 5k per year for the next 25 years. You think you will earn an average yield of 7% during that period. Your marginal tax rate is 38% and you will reinvest your 1^st and 2^nd tax return into your RRSP plan (38% of 5K is $1,500 and 38% of $1,500 (only starting the second year) is $722). After 25 years, you will get either $338,382 in your TFSA or $503,499 in your RRSP. For calculation detail, please look at the chart below:

Retirement

So let’s pretend that you don’t earn any other income but the one received from your TFSA or RRSP (it might be the very truth because of the babyboomers, who knows?). Since you are retired, your investment return should drop to 5%. If you withdraw 25K net of taxes, you would be able to do it for 23 years with the TFSA and 25 years with the RRSP (we have to count that you will withdraw at an average rate of 30% since you don’t have any income).

However, if you have other source of income (government’s pension, employer’s pension, rental properties, etc.) and you are still at 38% marginal tax rate, your RRSP account will only last 20 years.

The Conclusion

I would declare the TFSA the winner for the following 2 reasons;

- TFSA provide the contributor much more flexibility and withdrawals are tax free.

- RRSP accounts are competitive if you pay less than 32% average tax rate and you must invest all your tax returns into your RRSP in order to have these numbers. Then again, the TFSA is much more flexible.

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