1993'S BIG THREE QUESTIONS-AND THE ANSWERS
1 SHOULD YOU BORROW FOR YOUR RRSP?
Today financial institutions are vying for the opportunity to loan you money for your RRSP. Some institutions offer preferred beat-the-clock or early-bird bonus interest rates, while others offer RRSP loans at prime, at any time of year. Shop around.
Though you can no longer deduct the interest on an RRSP loan, it still makes sense to borrow money for your RRSP contribution, as long as you can pay it back within the year. Say you borrow $3,000 at 9 per cent to put into your RRSP, then invest the money at 7 per cent. The cost of the loan over the year would only be $270 — which you easily offset with your $1,200 income tax refund (assuming you're in the 40 per cent tax bracket). In exchange, you'd earn $210 on that $3,000 inside your RRSP, and it would continue to compound over the years.
SHOULD YOU PAY OFF THE MORTGAGE, OR CONTRIBUTE TO YOUR RRSP?
Compromise is the best route: put your savings into RRSPs, and then apply your tax refund to your mortgage. "You'll make mortgage payments for slightly longer," explains Paul Starita, president, Royal Trust Investment Services, "but the compounding effect of untaxed earnings within your RRSP for those extra years has such a dramatic effect on the end value of your RRSP that it's very foolish not to make this your basic strategy."
Say you buy a house with a $100,000 mortgage at 12 per cent, amortized over 25 years. You're in the 45 per cent tax bracket, you save $6,000 annually, and your RRSP earns 10 per cent annually. Within 30 years, if you opt to put all your savings against your mortgage until it's paid off, you'd end up with retirement assets of $966,291.
The alternative — to put your $6,000 savings into your RRSP, then use your $2,700 tax refund towards mortgage repayment — ultimately provides RRSP assets of $1,481,483.
You do spend $129,627 more in mortgage payments by opting for your RRSP first — but that still puts you ahead by more than $385,000.
SHOULD YOU BUY A HOME WITH RRSP MONEY?
Last year, the government announced that you could borrow up to $20,000, interest free, from your own RRSP, to buy a principal residence in Canada. As a Home Buyers Plan purchaser, you will have to repay into any RRSP you hold, at least onefifteenth of the loan annually starting in December, 1995. For details on how to take advantage of this plan, contact an accountant.
"If you don't have a home and can get one at a good price by the time this deal ends," says Gordon Pape, author of Gordon Pape's 1993 Buyer's Guide to RRSPs, "there's nothing wrong with using your RRSPs for this purpose. But you must understand the price you'll pay."
The younger you are, the greater the impact of removing money from your RRSP on its future value. If you're 25, planning to retire at age 65, with an RRSP that can earn 10 per cent per year, the final value of your plan will be reduced by over $26,000 for every $1,000 you borrow for your home, assuming you reimburse your plan according to the government's schedule.
If you're 35 years old, you only reduce the value of your plan at age 65 by about $11,000 for every $1,000 borrowed, because you're giving up 10 fewer years of tax-sheltered compounding.
At the complete opposite end of the age spectrum, if you're 71 — the age when you have to wind up your RRSP anyway — taking out $20,000 to buy a home could
be a great way of limiting your taxes until well into the next century. People who used this plan in 1992 aren't allowed to claim an RRSP deduction for the 1992 tax year for any contributions made after February 25, 1992. But you can carry forward your 1992 entitlement and use it in 1993.
WORK WITH YOUR EMPLOYER
A group RRSP can be an excellent alternative to a company pension plan. You don't have to worry about whether you're vested, and you can take your retirement plan with you wherever you go. Companies can also sometimes negotiate discounts on trustee and administration fees. If you make your RRSP contribution from every paycheque, you're making regular contributions by definition, which is one of the most important strategies around for maximizing your RRSP.
Some companies are even willing to match employee contributions to group plans with
contributions of their own. "It's beyond my comprehension how anybody can find a rationale for not participating in such a plan," points out Starita.
Other companies and associations work directly with mutual funds firms to offer employees easy access to an entire funds family through payroll deduction. "Our clients, which include the Canadian Bar Association and the Ontario Nurses' Association, want to provide service to their employees and value to their membership," explains Frank Santangeli, president of Finsco Services Ltd. "We provide employees with easy access to our mutual funds through educational work place seminars, through our 800 number, or in response to reply cards that appear in their association magazine or newsletter."
Because your employer can get permission from the district tax office to reduce your withholding tax at source, a group RRSP can enable you to enjoy your RRSP tax saving on every paycheque. If you contribute $100 per month, for instance, your withholding tax could be reduced by
BUILT FORA BUILDER.
$40, which means your net take home pay will only be reduced by $60. You could only have to pay $60 for a $100 RRSP contribution.
TAKE ADVANTAGE OF THE COMPETITION
Financial institutions and mutual funds companies are so eager for your business that they now offer creative financial incentives to up the voltage on your RRSP enthusiasm.
Many banks and trust companies offer bonuses of up to one-half per cent more interest for maximizing guaranteed-rate RRSPs, enrolling in their monthly savings plans, switching your business to them, or using their products and services.
If your bent is towards mutual funds, look for lower sales commissions, load costs, management fees and switching costs. Trimark, for example, pays sales reps an annual one per cent "trailer fee,” taken out of the funds management fees for as long as you keep your units. "You pay less to go in but you pay higher management fees down the road," explains financial broadcaster and author Gordon Pape. "Whether that's worth it to you is going to depend on the fund's performance and the comparable management fees charged by other companies.”
If you're knowledgeable enough, use a discount brokerage, which provides highly competitive fees for self-directed RRSPs, discounted loads on mutual funds, no additional transaction fees for switching from one fund to another over and above normal commissions, and deep discounts on commissions.
"In the next 10 to 15 years, I believe we're going to see a real explosion in affordable managed money for the masses," suggests Paul Bates, president of Marathon Brokerage discount investment services. His firm just started to offer an "allocation account" for customers with $20,000-plus to invest. For an annual fee that ranges from 1.75 per cent to 2.25 per cent of managed assets, a professional money manager allocates your investments — and rebalances them quarterly — into Toronto Index Participation Units (which are equitybased), a money market fund and a long-term Canada bond, based on your priorities as determined by a questionnaire. There are no additional fees or commissions, no matter how many trades are executed on your behalf.
MAKING THE BEST INVESTMENT CHOICES TODAY
The key strategy for planning retirement assets can be summed up in one word: diversity. Your RRSP portfolio should include fixed income investments, including term deposits, Guaranteed Investment Certificates (GICs), bonds and/or mortgage funds, as well as longterm and short-term growth investments (equities).
After all, even the professionals make mistakes in timing upcoming inflations, deflations, recessions, market swings or interest changes.
Many experts suggest that you keep your income-
The deadline for your 1992 RRSP contribution is March 1,1993.
The maximum you can contribute to your RRSP for 1992 is the lesser of:
18 per cent of 1991’s earned income or $12,500 minus your Pension Adjustment for
1991, minus Past Service Pension Adjustments, if applicable.
The maximum you can contribute to your RRSP for 1993 is the lesser of:
18 per cent of 1992’s earned income or $12,500 minus your Pension Adjustment for
1992, minus Past Service Pension Adjustments, if applicable.
You are entitled to carry forward potential RRSP contributions for at least seven years. Earned Income That Qualifies for RRSP Contribution Net income from employment Net rental income, less rental losses Net business income, less net business losses Taxable alimony and maintenance receipts, less deductible alimony and maintenance payments
Supplementary unemployment benefits Net royalties
Employee profit-sharing plan allocations Research grants, less allowable expenses Taxable benefits from wage-loss replacement plans
Disability pensions received from CPP and QPP
earning investments inside your RRSP, where they aren't taxed, and your growth investments, which are eligible for capital gains and dividend income, outside your RRSP, where they enjoy preferential tax treatment. That's only practical if you can afford to accumulate investments after you've maximized your RRSP contribution. But as Brian Cunliffe, vicepresident, RBC Dominion Securities, points out, "the key is to earn as much as possible in your RRSP, and if you think we're in a cycle where equities will outperform fixed interest rates, then why not buy equities for your RRSP?”
The younger you are, the more equity-based investments you should have in your portfolio.
Equities can be more volatile than debt instruments in the short term, but are a proven inflation hedge over the long term.
The older you are, the more fixed-income assets you'll want. How much fixed-income is appropriate? Your age should represent the amount of fixed income in your RRSP, suggests Philip Armstrong, president of Altamira Investment Services Inc. If you're 30 years old, for example, aim to have 30 per cent of your account in
fixed income investments and the bulk of it — 70 per cent — in growth assets.
Many experts feel you should never eliminate growth investments entirely, though. Even once you retire, you have years of spending to plan for. "By age 65, we still recommend minimum 20 per cent exposure in stock funds," says Armstrong. "Your life span could easily be another 30 years from that time, so you should have something in there to protect you against inflation.”
Some analysts take a more conservative approach, though. "I think most
vice-president with RBC Dominion Securities recommends:
1. Short-term fixed interest investments, including 90-day to one-year money market funds, to provide buying power if interest rates go higher or the stock market offers better values later in 1993 and 1994.
2. Good-quality government, corporate or strip bonds. You can still get 10-year-plus bonds at attractive rates.
3. Mutual funds invested in foreign bonds, to take advantage of the 18 per cent foreign content component and also enable you to benefit from the higher interest rates in Europe. Once foreign interest rates start dropping, these bonds should show good growth as well as income.
4. Good international equity funds, for the growth component of your RRSP.
individuals approaching retirement should be buying only fully guaranteed GIC-type products for their RRSP and keep their equity investments outside, and I don't make any
DESIGNED FOR A DESIGNER.
apologies for that," suggests Paul Delaney, a retirement income specialist who is associated with The Investment Shop. "They're trying to preserve what they've spent a lifetime accumulating, and the proximity to retirement dictates not putting the RRSP funds at risk at this particular stage of life."
Age isn't the only factor you need to weigh when determining the asset mix that's right for you. You also need to consider your risk tolerance, your need for liquidity, your level of income, your other assets, your exposure to tax, as well as your personal circumstances.
Rebalance your portfolio once or twice a year to reflect the asset allocation you're aiming for. "That will force you to do one of the toughest things for any investor: sell off assets that are doing well," says Altamira's Armstrong. "If you decide you want a 50-50 mix and your stocks become more than 60 per cent of your portfolio, you have to take the emotion out of investing by capitalizing on your gains and moving the proceeds into fixed-income investments."
CANADIAN EQUITIES, EQUITY-BASED MUTUAL FUNDS
Gordon Pope, financial broadcaster and author of many books on financial planning, including Gordon Pape's 1993 Buyer's Guide to RRSPs recommends:
1. Global bond funds. People should take advantage of their higher foreign content limits. The turmoil we've witnessed over the past year shows how important it is to get some international diversification into your RRSP. These funds offer protection against further falls in the Canadian dollar as well as good capital gains potential as interest rates fall overseas.
2. Canadian bonds or bond funds. I'm not hot on the economy right now, which is one of the reasons I'm hot on bonds. I think interest rates will continue to trend down.
3. International equity funds, preferably ones that are very selective, to give you dollar protection and international diversification in these times of economic weakness.
4. Mortgage funds, which should provide non-spectacular but still steady returns. Canadians tend to be good in not defaulting on mortgage payments.
5. GICs, only if there's a temporary upward spike in rates such as we saw in the referendum campaign. Forget about waiting for double-digit GIC rates to return. Consider eight per cent unusually high and grab it.
If you have the time and expertise to manage your RRSP closely, you could probably maximize your return in equities by investing directly in a self-administered RRSP and buying 15 to 25 common stocks in a variety of market sectors. The safest way to invest in equities for most people, though, is to spread the risk through good quality mutual funds, and hang on to your investment for at least 10 years.
Most companies can arrange automatic deposits into one of their funds — an ideal way to buy into an equity-based mutual fund. When you continue to buy units all the way down as shares go from $10 to $8 and then all the way back up to $10, for example, your fund will hold some shares worth $10 for which it paid as little as $8. Even if the market ends up where it started, you'll make money.
You may have to tough out a slow year for Canadian equities this year. Our dollar may continue to head downward and our recovery could well lag behind that in the United States. "Canadian stocks have been in the doldrums and may well continue to be in the doldrums this year," in the opinion of Gordon Pape. "We shot ourselves in the foot with our referendum: it perpetuated the political uncertainty surrounding this country and made Canada less desirable for foreign investors." If you're selective, there are values to be found. And eventually, what has gone down will come up. For this year, Pape suggests you look for a fund that uses a disciplined selection process, not one that invests in the broad market.
Top consultants consistently recommend you maximize the foreign content in your RRSP. Current tax proposals entitle you to put up to 16 per cent of your 1992 RRSP contribution into economies outside Canada, and the limit's going up to 18 per cent for 1993. "Canada represents only three per cent of the world stock markets by capitalization," points out Altamira's Armstrong, "so there's a lot of other opportunities out there that any prudent investor should look at."
Investing outside Canada will also protect you if you agree with the many experts who believe that the Canadian dollar will continue to decline.
A U.S.-currency account is particularly useful for someone planning to retire in the United States. "It eliminates the risk to foreign currency fluctuations that might occur 15 years down the road," says Cliff Prupas, the Bank of Nova Scotia's assistant general manager, product management, "and will ultimately provide a handy U.S. dollar income stream."
Henry Cole, vice-president, investments at Midland Walwyn Capital Inc., thinks that "quality U.S. growth funds will provide good returns over the next five to 10 years. Because the U.S. dollar is trading at a relatively low level compared to other currencies, it's cheaper for Europeans and emerging markets to buy U.S. products, and that should benefit good-quality American companies."
If you're really bullish on offshore opportunities, consider funds that can provide you with foreign exposure even within the 100 per cent Canadian portion of your RRSP. Most financial institutions offer fully eligible international or global
bonds or bond funds holding Canadian bonds issued in foreign currencies. In addition, most Canadian equity funds contain the
upper allowable limit of foreign content. "You could easily have an RRSP portfolio with 50 per cent of your content offshore," says Royal Trust's Starita.
PRECIOUS METAL FUNDS
Paul Starita, president, Royal Trust Investment Services recommends:
1. Bond funds for income. Switch into GICs immediately if yields go up.
2. International bond
funds to provide currency protection. Buy Canadian-issued, foreign currency denominated bonds, which are 100 per cent RRSP-eligible.
3. U.S. stock funds to take advantage of the predicted surge in the U.S. economy.
These specialty funds, which usually include gold, are a good hedge against inflation over the
long term. "Our funds have gold representation," says Steven Kelman, vice-president, corporate and public relations, Dynamic Fund Management Ltd., "because demand for gold has remained strong throughout the recession. Prices should rise."
We treat everyone individually. That’s why we tailor make our RRSPs to fit you. We offer everything from up to xh% Bonus interest to the Rate-Watcher GIC which provides the 2-year rate with 1-year flexibility. From Mutual Funds to Self-Directed RRSPs. Come to Scotiabank and get a great custom fit.
A Secure Future. Made To Measure.
If you believe that prices will eventually rise in oil and gas, paper and lumber, mines and metals, consider putting up to 15 per cent of your portfolio in one of these funds. "We think that the entire resource sector is very attractive at the moment," says Altamira's Armstrong, "especially if the Canadian dollar continues to drop, since most of these companies sell their commodities in U.S. dollars."
REAL ESTATE MUTUAL FUNDS
Although real estate too has fared badly over the past few years, when the business cycle picks up, today's glut of commercial space will generate the rental income it should. It's an excellent time to take advantage of the market's historic lows and purchase real estate funds as part of a diversified portfolio, says John Sutton, senior vice-president of marketing, North American Trust's RealFund. "Quality commercial real estate today will yield in excess of 10 per cent, which is all tax-protected in an RRSP."
Real estate funds are evaluated according to market appraisals, which may not reflect the actual price that the properties would get if they were sold. They generally charge a declining back-end load starting at five or six per cent. Most require at least 30 days notice before you can cash in your shares.
Income-producing vehicles, like GICs, term deposits and savings accounts, provide guaranteed interest within a fixed period of time. A deferred annuity, sold by life insurance companies, is comparable to a GIC or term deposit, and ultimately provides either a pay-out annuity or RRIF.
Even though interest rates have plunged dramatically downward, about 75 per cent of investors still prefer the security of these investments. The truth is, today's low inflation means that the real return on long-term GICs can still be very attractive. In the days when five-year term deposits were earning 12 per cent, inflation was running at nine per cent, making their real return only three per cent. At the
time of writing, when five-year GIC rates were 7.5 per cent, inflation was running at 1.5 per cent, explains Midland Walwyn's Cole. "You're getting a six per cent real rate of return, which is very high."
Nonetheless, financial institutions have realized that they've had to provide additional incentives, in the form of unprecedented flexibility, to keep customers.
Some of the major trust companies now offer cashable GICs, for instance — "a good place to park your money temporarily," suggests Pape, "and a good alternative to Canada Savings Bonds in an RRSP. They may in fact give you a higher yield than a money market fund."
Other institutions offer GICs that guarantee stepups in interest, early withdrawal privileges, automatic renewals to the savings vehicle of your choice with a "best rate" warranty, or free switching to a longeror shorter-term vehicle.
To protect yourself against interest rate fluctuations, Robert Glista, general manager of retirement services marketing at the Canadian Imperial Bank of Commerce, suggests you stagger the maturity date of your GICs. If you are investing $7,500 in your RRSP this year, for example, he suggests you put $1,500 into a one-year GIC,
$1,500 into a two-year GIC, $1,500 into a threeyear GIC, $1,500 into a four-year GIC and the final $1,500 into a five-year GIC. "Then, as they mature each year," he says, "always renew them into fiveyear term GICs. The five-year rate generally provides the highest possible return, up to two percentage points higher than one-year returns. A portion of your funds will come due each year, which will enable you to take advantage of opportunities. Should rates go up, you're able to renew one-fifth of your portfolio. Should rates go down, you don't have to worry about renewing all your savings, and the majority of your funds are locked in at the higher rate."
Once your assets have grown large enough, you may also want diversity among interest-earning securities. A brokerage account can invest in GICs from several different issuers and provide you with one statement, suggests Midland Walwyn's Cole.
Only invest in institutions protected by Canada Deposit Insurance, which covers up to $60,000 of principal and interest.
Bond funds, which invest in corporate and government
securities that mature every few years, provide fixed income, and ultimately repay the principal at maturity. The term of underlying investments is longer than money market funds but shorter than most strip coupons. However, bonds are considerably more flexible than fixed-rate GICs, because they fluctuate in value according to each day's prevailing rate of interest. So if you buy into a bond fund when interest rates are eight per cent, and interest rates then drop to seven per cent, your bonds are worth more: the value of your investment has increased.
An astute fund manager can take advantage of prevailing market conditions. If interest rates are steady or on the rise, for instance, the strategy is to invest in relatively shortterm bonds, which are replaced with higheryielding instruments upon maturity.
If interest rates are declining, long-term bonds provide superb returns as investors who bought bond funds over the past couple of years happily discovered.
This year, with interest rates down and more likely to rise than fall, fund managers recommend caution. "The rates of return will be moderate over the next year or so," thinks Dynamic's Steven Kelman, "but you'll eventually benefit as the economy improves and the demand for capital picks up."
Steven Kelman, author of RRSPs 1993 and vice-president, corporate and public relations, Dynamic Fund Management Ltd. recommends: 1. Equities. Canada is moving out of its recession, and the U.S. economy is recovering, which should benefit the
Canadian export industry. The lower Canadian dollar and low interest rates should mean higher profit margins.
2. International global bond funds, which hold bonds issued by Canadian provinces, in foreign currencies, if you're not psychologically ready to go into equities. European rates are abnormally high by historical standards. Once rates come down to spur the European economy, these bonds will surge.
3. Asset allocation fund, if you want a mixture of stocks and bonds but don't want to manage the mix yourself on an ongoing basis. Dynamic Partners Fund is moving towards 60 per cent equities and 40 per cent bonds. The equities are heavily weighted toward natural resource companies, which will benefit from North American economic recovery. Our bond managers are shortening the maturities of our bonds, and intend to replace some North American exposure with European exposure using RRSP-eligible securities.
Strip bonds lock you in to a fixed rate of return over a maturation period that can run up to 30 years. They're therefore very desirable when interest rates are high. Consider them "if we get a temporary spike in interest rates," says Pape.
Mortgage funds pool thousands of mortgages. How well the fund performs depends on whether the terms are
short or long, the direction of interest rates and the security of the real estate they're on. When interest rates drop, the older mortgages locked in at high rates offer considerable protection. If interest rates start rising, on the other hand, and the majority of the fund's terms are relatively long-term, the fund could be locked in to a disproportionate number of mortgages at yesterday's low rates. "Make sure your expectations are realistic," suggests Dynamic's Kelman. "Ask your bank or trust company representative to determine the total return you would get if interest rates went up a point, say, over the next 12 months, before you invest." Read the prospectuses carefully, and make sure they're NHAsecured as protection against defaults.
MONEY MARKET FUNDS
Because money market funds invest in short-term (usually up to 90-day) government and corporate treasury bills, they're most profitable when short-term interest rates are high. When rates start falling, the returns on money market funds drop continually, too: "They offer you a temporary opportunity to take advantage of higher yields until the reinvestments catch up with current rates,” explains the Bank of Nova Scotia's Cliff Prupas. If you're looking for a place to park cash in the short term, money market funds could offer slightly better returns than a daily interest savings account. But you might be better off with a longer-term, interestyielding vehicle or a cashable GIC.
ASSET ALLOCATION FUNDS
These funds, also known as balanced funds, contain a mix of equities, bonds and cash. They could be your ticket to all the diversity you need, in a single investment. You get some of the prospects for the capital gains growth associated with equities, as well as the greater safety of principal and the income stream of fixed income funds. Look beyond the fund's track record and management to find out its investment policies, especially how the managers determine its weighting, to make sure their guidelines, comfort zones and priorities match yours. ■
This supplement was written by Toronto freelance writer Helen Kohl.