Right now, many Canadians are asking themselves some variation of this question: “What’s the perfect RRSP investment?”
The short answer is none. There are flaws in every security you might consider for your registered retirement savings plan, from low return to high risk. But there are many that offer a reasonable combination of risk and return, and that’s where you should focus your attention. What should you look for? Here are four guidelines to work with.
This should be your starting point. The financial industry is legally required to tell you that previous results are no guarantee of future returns. That’s absolutely true, but they’re the best indicator available of what to expect, assuming consistent management.
I suggest that any equity-based security that boasts an average annual return of 8 per cent or more over the past 10 years is worth considering. For a balanced mutual fund or exchange-traded fund, a 6-per-cent average annual growth rate is a fair benchmark. If you’re looking at fixed-income investments, a range of 4 per cent to 5 per cent is reasonable.
Your ideal investment should have a degree of predictability. Unless you invest in a guaranteed investment certificate, you shouldn’t expect the same return every year. But you want to avoid securities with wild price swings. High volatility will raise your stress level and could lead to emotional buy-sell decisions, which often turn out badly.
Balanced mutual funds or ETFs are usually good choices for consistency. Among stocks, look at well-established utilities, such as Fortis Inc.
Some people regard costs as the No. 1 criterion in selecting securities. If it’s too pricey, they don’t buy – period.
It’s true that high fees can erode your returns over time. Discount broker Questrade estimates that, over 30 years, a 1-per-cent differential in fees will make a difference of 27 per cent to 29 per cent in the end value of a portfolio.
But that’s all things being equal. If an actively managed mutual fund consistently outperforms a passive ETF, it’s worth the extra expense.
To cite one example, the Mawer Canadian Equity Fund generated an average annual return of 10 per cent over the decade to Dec. 31 with a management expense ratio of 1.16 per cent. The iShares Core S&P/TSX Capped Composite Index ETF produced a return of 6.77 per cent annually over the same time frame, even though its MER is a tiny 0.06 per cent.
So yes, costs are important. But they aren’t the whole story.
Warren Buffett’s first rule of investing is, “Don’t lose money.” The billionaire investor’s second rule is, “Never forget rule No. 1.”
This holds doubly true for RRSPs. Any money lost within the plan cannot be replaced. It’s gone, and the years of tax-sheltered compounding it would have generated are gone as well.
That’s why it’s important not to use your RRSP to speculate. If you want to buy penny stocks or invest in what you think is the next great tech startup, do it in a non-registered account. At least if you lose there you can write off the loss against any capital gains. There are no write-offs for RRSP disasters.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.