With more and more evidence that Canadians are not financially preparing for retirement, the need to start saving earlier in life and put in place sound financial RRSP strategies are becoming increasingly important.
A recent annual survey by Bank of Montreal found that the number of Canadians who have an RRSP is increasing. Unfortunately, most are not contributing anywhere near the maximum they can.
The report found that 67 per cent of Canadians have an RRSP, up six per cent from 2011, and 72 per cent expect to contribute the same amount as they did last year. However, the annual contribution last year was only $4,670 – about 21 per cent of the annual allowable contribution room – and industry reports now suggest that total unused RRSP contributions will hit $1-trillion by 2018.
“The trend is encouraging, but it is not moving fast enough,” says Steve Shepherd, vice president and investment strategist with BMO Global Asset Management.
Only 49 per cent of younger Canadians between the ages of 18 and 34 plan to open an RRSP in the next five years and a little over half of that age group plan to, or have been making contributions toward their RRSPs. Only 30 per cent know the size of their annual RRSP contribution limit.
Young people in their 20s often make the mistake of not investing because they don’t feel they have enough money at that stage in their lives to make it worthwhile.
“Forty per cent don’t feel they have enough saved to invest,” says Shepherd. “But it’s important to get into the savings habit, even if it’s only $50 a month because what’s important in investing is how long you’re in the market. The sooner you get started the better.”
A portfolio at that stage of life could typically be more heavily weighted to long-term equities, but the decision often will be determined by an individual’s risk tolerance. Given the current low interest rate environment, long-term returns can be a lot higher than what you can get from fixed income, overcoming inflation and still providing a real return.
“In the 20s a lot of people might have a figure in mind that they need for retirement, but as their lifestyle builds by the time they hit 55 they realize that figure won’t do and they should have been saving more and should have tweaked their plan,” says Bill Jack, Toronto regional director with Investors Group Inc. “A plan has to be fluid and change over time.”
In their 30s and 40s, people tend to get married, have children, buy a house or condo and one of the spouses or partners may leave the work force, resulting in higher household debt and lower income.
In this stage of life there may be more opportunities to save through other options like the Tax-Free Savings Account (TFSA), Registered Education Savings Plan (RESP) and Registered Disability Savings Plan (RDSP).
“These are all available, but you need to have a sound budget,” says Shepherd. “A portfolio would typically become more conservative with less volatility but still with some growth – perhaps about 55 per cent in equities and 45 per cent in fixed income including about 25 to 30 per cent in bonds.”
Portfolios during the 50s and 60s would typically become more balanced, shifting away from volatility and equities and more into fixed income. A lot of people make the mistake of just looking at what kind of returns they think they will need in retirement without factoring in other influences such as inflation.
“People may have been saving when interest rates were high and inflation low, but what if inflation goes up to five or six per cent a year?” says Shepherd. “When you factor that in to retirement, it can really erode your income’s buying power.”
Shepherd says in this stage of life people need to think very hard about what rates of return they think they’ll need, be conservative but still keep their portfolio diversified enough to provide some growth to counteract inflationary pressures.
After age 65, the primary financial focus generally is on generating a steady income stream and protecting it from the ravages of inflation and taxes. As salary or wages decrease or stop, investments must produce sufficient income to help supplement government and private pension benefits and other income.
As an investment strategy, a retiree’s portfolio should place a greater emphasis on income-generating stocks and bond funds and annuities. However, growth stocks and mutual funds should not be entirely discounted. Growth-type investments still can serve a useful purpose in the battle against inflation.
Shepherd suggests laddering fixed income investments over a five-year period to help reduce interest rate risk, and consider an allocation in higher-yielding corporate bonds, as well as real return bonds to address inflation risk.
Options for investors seeking a simpler way to manage such asset allocation decisions are managed portfolios of exchange-traded funds (ETFs) and mutual funds like the BMO Life Stage Class funds, which become more conservative over time as they approach maturity.
And seek the help of a professional adviser.
“Studies have shown that investors who work with an adviser get three to six times more in investment capital,” says Jack. “The reason is that they make you go through the exercise of setting goals and then ensure checks and balances are in place to help you get there.”