As an investment adviser who talks with many different clients every day, I have observed some common themes popping up with more frequency as the March 1 registered retirement savings plan (RRSP) contribution deadline looms. So often, people want to know about best practices, dos-and-don'ts and top tips. These are recurring questions and anxieties about their investment strategies.
Below are the answers to three pressing RRSP planning issues that seem to be on the minds of investors right now.
Time horizons matter
Generally speaking, a 25-year-old and a 65-year-old will have different investing outlooks when it comes to retirement. Younger investors tend to have a longer time horizon – they can leave their money in the market for longer and have many more years in which to earn income and adjust savings – than older investors. They are better positioned to tolerate the volatility inherent in the higher-returning asset classes of equities.
In comparison, those who are about to retire have significantly shorter time horizons. They have fewer years in which to earn income and adjust savings should anything happen in the market; therefore, they have less ability to accept the volatility inherent in a portfolio with a higher equity weight.
When you are setting up your RRSPs, one of the very first and most important things to get right is a match in your time horizon. This is a mistake we see all the time. Curiously, it is particularly common among young investors who end up choosing too conservative an asset mix. Often, this is because the investor is overly concerned about the state of the world and is losing sight of the fact that they have a really long time horizon to recover from temporary dips in the market.
When you factor in the effect of compounding wealth over time – the true wealth generator – the choice to be overly conservative when you don't need to be can result in the loss of thousands, if not millions, of dollars.
Make peace with short-term volatility
Sometimes, investors just get too caught up in listening to all the noise – the day-to-day noise that inundates us from our devices; the headlines written to shock; the constant access to information. What the market is doing day-to-day can seem quite volatile at times, but the fact of the matter is how little short-term volatility may impact your portfolio over the long-term.
For an investor with an investment horizon of 20 years, an entire year equates to 5 per cent of the entire time horizon. While it can be difficult to watch a volatile portfolio, a year is a relatively small time frame when taken in perspective of the portfolio's time horizon. Add to this that if you are buying a fixed dollar amount in regular intervals, you experience the benefit of dollar cost averaging – buying more shares when prices are low and less when prices are high. This can alleviate some of the anxiety around investing as you will continue to build your investments over time, no matter what the market is doing.
Stop chasing returns
If you get too wound up in those day-to-day concerns and lose that long-term focus, you also may be more susceptible to what the industry calls chasing returns – switching from one investment into another that has had excellent recent returns.
We've all seen the disclaimer "Historical returns are not necessarily indicative of future performance," and it's true. But looking at past performance is often one of the ways we can gauge whether a mutual fund has done better or worse compared to its objectives or peers. When you do review the performance history of a certain investment, we believe that longer is better (such as five years, or 10 years or more). This allows you to see how it has performed over at least one or two economic cycles.
We're not saying that considering a new direction for your investing strategy is always a bad idea. But when you do decide to make a change, it is important to go back to your original investment objectives and ensure that what you are about to embark on still plays to your plan. You should ultimately have a robust and diversified portfolio that is uniquely positioned for your goals and risk tolerance levels.
Planning for retirement is no small feat; there are definitely stresses and anxieties around the uncertainty the future brings. That's why I'm going to say something that you've heard a million times before (because it really does matter):
Always seek the advice of a qualified investment professional before you invest. They can help you see the forest for the trees during this RRSP season and perhaps provide some peace of mind.
Gavin Mahabir is an investment adviser with Mawer Direct Investing Ltd.