As the March 3 deadline approaches and the pro-RRSP message is trumpeted by TV ads, billboards and media stories, Canadians across the country are saying to themselves: I think I need one of those.
More often than not though, people land in front of a financial adviser with little knowledge of the investment vehicles they plan to buy.
Many people who are looking to invest in a registered retirement savings plan often don’t even know what an RRSP is, says Carl Spiess, director of wealth management for ScotiaMcLeod.
“There are way too many people who think an RRSP is an investment, and it’s just an account,” Mr. Spiess says. “People walk in and have this idea, ‘I need to buy an RRSP,’ and it’s no, you need to put money into an RRSP to shelter it from tax and then decide on your investment.”
When it comes to RRSPs, the investment options are plentiful, from exchange-traded funds to mutual funds to stocks and beyond. The first step is talking to a financial adviser about whether an RRSP is the right choice for you and your financial plan, says Richa Hingorani, senior manager of financial planning support at Royal Bank of Canada Financial Planning.
“Don’t make temperamental decisions at this time of year just because of wanting an income tax break or because you’ve been hearing about ETFs or a particular stock,” Ms. Hingorani warns. “Average Canadians spend more time planning their vacations than managing their investments.”
To give you a head start before you make that RRSP appointment, here’s a primer explaining some of the most popular investment options, and why you might want to consider them – or not:
1. Guaranteed income certificates
With a GIC, you are agreeing to lend a financial institution a sum of money for a period of time (a term). These investments appeal to risk-averse investors, because they are guaranteed to get that same amount of money back at the end of the term, plus a fixed rate of interest (Note: Some market-linked GICs offer a variable interest rate.)
GICs are considered a “safe” choice for investors, but the trade-off is that the interest rate is low – typically 2 or 3 per cent. In general, the longer the term, the better the interest rate.
Mr. Spiess says a short-term GIC can be a good choice for someone planning to utilize the funds within a year or two. Or for a very risk-averse investor, a “ladder” of GICs could be an option worth considering. To create a ladder, you divide your money equally into GICs with terms of one to five years. Each year a GICs comes due, you roll it into a new five-year certificate, so you can take advantage of rising interest rates, while limiting your exposure if rates fall.
“Ladder GICs seem to be very popular because you are not leaving it up to one rate of return,” Ms. Hingorani says. “You are taking care of a lot of reinvestment risk, and you are never at the mercy of the markets.”
With bonds, you are acting as a creditor, lending money to a company or government. Bonds have a set term (which can be as short as six months and as long as 20 or 30 years) and a set interest rate. When the bond matures, you get your money back plus the interest you are owed. Some bonds have floating interest rates that go up or down over time.
Bonds have traditionally been seen as a lower-risk, lower-return choice (in comparison to a stock, for example), but there are still risks. Credit ratings, inflation and interest rates can affect bonds. If, for example, you buy a bond at 3 per cent and then interest rates go to 1 per cent, your bond becomes valuable. However, if interest rates go up to 10 per cent, your bond is no longer appealing to buyers. If you need to sell a bond before its maturity date and it’s worth less than you bought it for, or if the issuer goes bankrupt, you can end up losing money.
“Going into a straight bond, like a 10-year bond, if interest rates go up over the next year, the market value of that bond can decline, and that can be unnerving for a novice investor,” Mr. Spiess says.
3. Mutual funds
Canadians like their mutual funds. As of December, mutual fund assets under management in this country totalled $999.2-billion, according to the Investment Funds Institute of Canada.
A mutual fund is a portfolio of bonds, stocks and other assets owned by many investors and managed by an investment company. Because the investments of many are pooled, it allows individuals to be diversified in a way they couldn’t be on their own. The idea is that your risk is minimized because your money is in an array of investments, and your returns can be higher than GICs or bonds.