The two most common mistakes Canadians make with their registered accounts are procrastination and over-contribution. Many people procrastinate in making contributions to their RRSP or TFSA account. Often, people think it would better to contribute when their income is higher. Unfortunately, this prevents them from reaping the benefit of compounding.
With RRSPs in particular, the single most common mistake is over-contribution. The allure of tax-free growth can make investors overstep the contribution limit, which results in penalties.
I’ve found that two investing habits offer the best defence against these mistakes, as well as some others people make with their savings.
Decide on an investment amount
The ideal situation would be to contribute as much as your TFSA and RRSP contribution limits allow. That’s fixed for the TFSA and dependent upon your income for RRSP. Let’s say you earn $70,000 a year and live in Ontario. If you decide to contribute the maximum to both your RRSP and your TFSA, it will amount to $18,600 ($12,600 for RRSP and $6,000 for TFSA). Your total tax for the year will be around $13,557, including a $3,736 RRSP tax deduction.
This seems to shrink your net income quite considerably. But even if you can’t fill your TFSA and RRSP to the brim, regular contributions can make a lot of difference in the end. It’s better to start investing small amounts now than waiting to invest larger amounts later. Investing only a fraction of the total contribution limit for a longer time is usually better than investing the full amount for a shorter time.
Let’s say you can only contribute one-fourth of your total TFSA contribution room right now. That’s $125 a month, for a total of $1,500 for the year. If you keep up with that schedule for 30 years, with 5% returns, you will accumulate over $100,000. And only $45,000 of it will be your invested capital. In contrast, if you contribute $500 every month for only ten years, at the same return, you will get $78,000 ($60,000 capital).
The numbers don’t always come out as clean-cut, but it’s a good example of how even a small but consistent investing amount can make a difference. You can keep increasing the amount you contribute in proportion to your income.
Create a contribution schedule
The best way to make sure you are saving enough is to set aside a set sum from your paycheque for saving and investing. If you wait till the end of the month to put aside what’s left, the chances are that you won’t have a consistent amount. But if you set aside money in the beginning, you are likely to make do with what you have left for monthly expenses. This goes hand in hand with deciding on a set amount for saving and investing.
If you don’t know much about the stock market, you may also create an investing schedule. You may decide to buy stocks of Toronto-Dominion (TSX:TD)(NYSE:TD) on every month’s tenth day, for example. But if you have developed a better understanding of the stock, you can make the purchase when the stock is trading at a relatively lower price.
Toronto-Dominion is a dividend aristocrat with an impressive dividend growth streak. The yield is currently hitting almost 5%. But it’s likely to stabilize once the market regains its momentum after the coronavirus pandemic is over. Buying a few stocks every month, or every few months, in a company like this can help increase your dividend-based compounding. It may also offer decent capital gains if you hold on to it for long enough.
Even if you are earning enough to easily contribute the full allowed amount to your TFSA and RRSP, a fixed savings amount and a contribution schedule can help you avoid over- or under-contributing. Making sure that a certain amount is going in your investment vehicles every month will let you make the best use of these accounts. How much you can grow them will depend more on your stock choices.