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Dear Fellow Fools,
There are many important dates on the calendar: Christmas, birthdays, scheduled oil changes …
Here’s one that’s not important, however: Canada’s annual RRSP deadline.
This flies in the face of what our country’s financial industry would like you to believe. Every year, we are inundated with reminders of this looming “deadline.”
As today is the RRSP deadline, I’d like to do some myth-busting and outline an easy-to-implement strategy that will allow you to save for your retirement and not fret about this over-emphasized “deadline.”
But First …
Our last Take Stock tried to convey one of the basic features of an RRSP – the ability to compound your savings free of tax. Several astute readers sent us constructive feedback on that message (thanks to each of you!). The most common among the responses was, “True, but you are still taxed on these savings when you begin to withdraw from an RRSP.”
Many more implications were also brought to our attention, which speaks to the complex and personal nature of tax-related topics. We were shooting for a one-size-fits-all type thesis, and this proved to be a bigger challenge than originally expected.
To briefly return to our last Take Stock and try to clarify one of our primary points: If you were given the choice between having $80 to invest today or $100, which would you select? From the perspective of an investor, it’s difficult to fathom a circumstance in which we’d take the $80. Take the $100 and let the magic of compounding take over. That’s essentially what an RRSP does; it gives you $100 to invest today instead of $80.
At the risk of again glazing over a plethora of intricacies, this week we’re going to propose an idea that could be a good fit for most individuals saving for retirement.
Given all the noise surrounding the coming RRSP deadline, we suspect not enough are doing so. A recent CIBC poll helps to confirm this suspicion.
When it comes down to it, today’s RRSP “deadline” is really nothing more than a marketing ploy by Canada’s financial industry to get you to “act now, or else.” Urgency is a powerful marketing tool — and so most marketers will use it when possible (us Fools included).
But in reality, RRSP “season” is an all-year celebration.
You can stick your hard-earned savings into an RRSP any day of the year you’d like. In fact, it’s more likely that you’ll save a bigger portion of those dollars if you do it in regular, bite-size installments rather than waiting for the first business day of March and scrambling to sweep up whatever loose change you might be able to get your hands on.
Psychologically, you’re likely better off making regular, pre-scheduled bite-sized contributions rather than large, one-off deposits you can easily talk yourself out of. Most full-service or discount brokerage operations are more than able to set you up on this kind of a plan. A pre-authorized contribution (PAC) plan is not only a way to ensure you’re committed to saving for retirement, but also a way to ensure you’re investing on a regular basis.
Where Should the Money Go?
Not only will money be flowing out of your day-to-day bank account into a tax-sheltered vehicle, but because of this regular flow, you’ll be able to take advantage of two of the coolest tools that help ensure long-term investing success – dollar-cost averaging and the magic of compounding.
For the less experienced amongst us, the perfect place for these bite-sized contributions to flow is into a low-cost index-tracking fund. What might come as a surprise is that, for most, I’d caution against utilizing an exchange-traded fund (ETF) as the investment vehicle of choice.
In most circumstances, a good old fashioned mutual fund is in fact the more cost-effective vehicle for this kind of strategy.
Don’t get me wrong — there is plenty wrong with mutual funds and in many cases, an ETF is the more appropriate choice between the two. However, in this scenario where you’re putting a bit of cash away, say, on a monthly basis, the mutual fund is the way to go.
Even though there is a sizeable difference in the management expense ratio (MER), which is usually why the ETF wins this comparison, most mutual funds these days are free to purchase. That is, there’s no upfront cost.
That’s not the case when it comes to an ETF. For the most part, ETFs trade like individual stocks — and therefore commissions are associated with each ETF trade. Though commissions continue to come down, even at $4.95 per trade (the lowest Canadian rate I know of), if you’re investing a few hundred dollars per month and your total dollars invested in the product are still relatively small, the $60 or so you’ll spend making 12 separate ETF purchases is far more than you’ll spend on mutual fund-related expenses for a similar set of transactions.
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Like our last Take Stock, this proposition is not intended to fit universally. For instance, if you’re lucky enough to be contributing thousands per month to your RRSP, an ETF is potentially more cost-effective.
The advice is more applicable to those who can’t achieve this level of savings, and who are closer to the beginning of their journey through the world of investing. In our mind, if you’re a relatively new investor and are looking for a great way to get started, or simply would like to begin making more regular contributions to your retirement account, a pre-authorized contribution plan directed toward your RRSP can be a powerful tool to get you on the path to building a portfolio.
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Chief Investment Adviser
Motley Fool Canada