Are you a baby boomer looking forward to retirement?
If so, it pays to have your RRSPs in order.
An RRSP, if used properly, is the best tax-deferred account you can get. Offering both tax deductions and tax-deferred growth, it’s perfect for long-term saving. Used incorrectly, however, it can get you into trouble.
If you’ve been investing in RRSPs for a long time, you’re probably aware of the risks of over-contributing and withdrawing early. These dangers are very well known. However, there’s a more subtle, less-discussed risk that could bite you in the behind … one that your financial advisor may have an incentive to hide from you. This is a trap that many investors fall into without ever being told about it. And over the long run, it can seriously eat into your returns.
Investing in high-fee mutual funds
Investing in high-fee mutual funds is one of the easiest ways to deplete your RRSP holdings while doing everything “right” on paper.
It’s easy enough to avoid over-contributing or withdrawing early. Not only are most investors aware that those are big no-nos, but they’re also being reminded of them constantly by their financial advisors.
The more subtle mistakes are the ones where your financial advisor may benefit from you making them.
Many financial institutions — including Canadian banks — aggressively promote high-fee mutual funds, because they’re more profitable than low-fee index ETFs. This makes them more money, but it can come at your expense.
Why it’s such a mistake
High fee mutual funds are usually bad news for two reasons:
- These funds rarely outperform their benchmark, so have no advantage on index funds.
- Their fees can be quite exorbitant.
This is a double whammy of costs that can really eat into your returns over the long run. According to a March CNBC story, 64% of active fund managers lagged the market for nine consecutive years ending in 2018. That’s a whole lot of underperformance, and if you’re paying, say, 2% a year in fees on top of that, you’re essentially throwing money down the toilet.
What to do instead
If you’re worried about fund managers crashing your RRSP and charging you for the privilege, there is one simple solution: invest in index ETFs.
Index ETFs are tied to the market, virtually guaranteed to deliver average returns and have fees as low as 0.02%. It’s an overall package of benefits that actively managed funds can’t match. And best of all, being traded on exchanges, ETFs are ridiculously easy to buy.
One index ETF that all Canadians should consider owning is iShares S&P/TSX 60 Index ETF. In past articles, I’ve extolled the virtues of this fund at length, and it has still more things going for it that I’ve yet to cover.
First off, it has low MER of just 0.18%, which is far lower than most actively managed funds out there. Second, it’s a TSX 60 fund, so it enjoys a slight performance advantage over the TSX composite fund. Third, it has a fairly high dividend yield of 2.8%. Finally, it’s run by Blackrock, a very well-respected financial services firm that investors can trust.
All in all, the above factors make XIU a great pick for investing passively in your RRSP while avoiding the pitfalls of active management.
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Fool contributor Andrew Button owns shares of iSHARES SP TSX 60 INDEX FUND.