Over the course of my career I’ve met a number of clients who absolutely refuse to put any money into a registered retirement savings plan. They are mainly small business clients who see the government as the “evil empire” and feel as if they’ve paid their fair share of taxes to CCRA. All of us feel over-taxed in Canada; we are one of the highest taxed societies in the modern world.
Taxes are a part of life and the best way to minimize this burden is to invest in the only legal, sensible investment available to every working Canadian; RRSP’s. I say legal because although the government has put limits on how much you can invest; you are eligible to save up to 18% of your annual income (minus your pension savings) to a limit of $19,000 for the 2007 tax year.
There are a lot of people who have tried to devise elaborate tax loopholes like off-shore investments, labor sponsored venture capital investments, and even income trusts. However in my experience, all of these investments end up doing is increasing the level of risk you are taking to unacceptable levels and allow you to have “capital losses” which can be offset against future capital gains, but who wants to invest with the intention of having a capital loss? I know I don’t.
The only prudent way to insure you can reduce your tax burden is to first maximize your RRSP room and after you’ve done that, invest in good stable- dividend paying companies that have a potential for capital gains outside of your RRSP.
If you know little or nothing about investing, don’t worry. Some of the most successful clients I’ve met don’t know a thing about it either and they do well because they don’t let the market “noise” dictate their actions. The one thing you cannot control is the direction of the market and any advisor who tells you he or she can guarantee that you will have a 10% return from this investment every year for 30 years is lying.
True the Canadian market has averaged 10.55% over the past 40 years before taxes but there have been some very turbulent times during that period. You have to have the discipline to keep investing even though you see the market value of your investment decreasing. There has never been a 10 year period in history that has produced a negative return for any well diversified investor.
It is very difficult to continue to contribute to an investment when you can see the market value of your portfolio constantly decreasing, but that is what successful people do. You need to follow Warren Buffet’s axiom, “when people are greedy, be fearful and when people are fearful, be greedy.”
Some of the most successful clients I’ve worked with are the ones who continued to contribute during the recent bear markets of 2001 and 2002, and they were rewarded for it. The TSX returns during those times looked like this:
2000 7.41%
2001 -12.57%
2002 -12.44%
2003 26.70%
2004 14.50%
2005 24.10%
2006 11.80%
It’s a real challenge to keep investing in a market that seems like it’s in free fall, but markets will always be turbulent. Buy-in consistently and it’s not something you need to worry about.
What you should be concerned with is the “quality” of your investments. What are the fees you are being charged on your mutual funds? How long has the management been with the fund? Is their a front-end, back-end or deferred sales charge on your funds?
Why? There are investment options out there that are low cost, no deferred sales charge that have excellent performance. The only problem is that they don’t pay your advisor in the same way that the “heavily loaded” funds do. Walk into any bank and you can buy a no-load, good performing mutual fund with little obligation to stay with the fund for more than 90 days.
Discuss options with an insurance agent or independent financial planner and you will most likely be locked-in to under performing, heavily loaded fund(s) for 7 years or more. You need to decide what is best for your particular situation but remember, you are your best advocate and you must ask the tough questions to your planner.
If you feel as if your planner is doing a good job for you then most likely he/she has you on a “regular investment plan.” The advantages of a regular investment plan into an RRSP or group RRSP (most employers offer a group plan) is that you are dollar-cost-averaging with your contributions.
When you consistently invest in a plan and the markets are falling you are actually buying more units at a lower price and when the markets turn around, you get the advantage of having more units grow for you. Thus increasing the value of your overall investment.
Consistently investing in an RRSP also has the advantage of tax-sheltered growth. Simply by contributing $750/month in a portfolio with an average return of 7.5% for 30 years, will give you $1,010,584 in RRSP’s. They can continue to grow until you are ready to withdraw from the plan.
Contributing that same $750/month in a non-registered portfolio will produce an after-tax return of about 5.1% (assuming a 32% tax bracket) and after 30 years will give you $635,863. A difference of $374,721. Keep in mind that the RRSP’s are pre-tax and the non-registered portfolio is post-tax but the major advantage of having that additional $374k is that it can continue to grow for you in the future. Why pay the tax up front when you can defer it until much, much later.
Having capital of $1,010,584 at 7.5% return will give you $75,793 that year; having capital of $635,863 at 7.5% return will give you $47,689 that year. The amount of capital you have invested makes a big difference.
A good rule of thumb I try to instill in all investors is to contribute 10% of your income into a regular investment plan. If you cannot afford to save 10%, then your lifestyle requirements are too big for your income. I believe that you should be able to survive on 90% of your income no matter how much you make. If your gross pay is $2000/month, save $200/month into an investment. If it’s $5000/month, then save $500/month into an investment. The math is easy the important thing is to get started and get started now!
Don’t wait until this payment is done, or that loan is finished, start now. There is always going to be something for you to pay down no matter what stage of life you are in. Saving regularly forces you to pay your self before anyone else, and this is the most important payment that you will ever have to be made.
The average Canadian changes careers 4 or 5 times in their lifetime. This doesn’t give you a lot of security in a retirement pension, and seniors today who rely on government pension are living well below the poverty line. Do yourself a big favor and start something now.
If you are already investing, invest more. The number of years you have to invest is the most important component to your financial future.
Let me explain, if a 20 year old invests $500/month for ten years and then does nothing for the next 35 years, they will have accumulated $1,118,185 by age 65 (assuming an average of 7.5% return). Now if they waited until they were 30 years old, the same individual would have to contribute $500/month for the next 36 years and two months to have the same amount as they would have had if they started at 20 years old. That’s the power of compounding.
This RRSP season my advice is to start a regular investment plan and pay yourself first before anything else. Remember to ask your advisor the tough questions. No question is a dumb question. It’s your money and you need to understand where it’s invested, but don’t let market turbulence distract you from your long-range goals.
