Fluctuations of little concern to investors who keep long-range focus
by Paul Emerton
To ensure maximum benefits for your retirement years, consider your RRSP an investment, not a savings account. By investing in stocks and equity-based mutual funds—funds that invest in companies listed on the Toronto Stock Exchange and stock markets in other countries—you’ll build a much larger retirement nest egg.
Stock markets can be volatile, however, and if sudden changes in their value cause you sleepless nights, here’s how to enjoy less concern and more returns.
It’s a long journey. From your 20s to your 50s, building your RRSP is like travelling to a distant destination. With that analogy, sudden drops in stock market values become traffic jams and detours. They slow you down somewhat, but make less impact in the long run than you think.
Avoid putting all your eggs in one basket. Protect against RRSP losses due to market volatility through diversification— investing in a variety of market sectors and countries. This spreads the risk and reduces the impact if one sector suffers major losses.
Profit from volatility. Instead of making annual lump-sum contributions to your RRSP, invest an equal amount to purchase stock or mutual fund units each month. This strategy, called dollar-cost averaging, ensures that you purchase more shares when the price is low and fewer shares when the price rises. The average amount you pay per share or unit will almost always be lower through dollar-cost averaging. Ask your financial advisor for details.
A simple rule for sleeping better. Two suitable investments for your RRSP are stocks and government-backed bonds, and both should be included in your RRSP portfolio. Bonds backed by Canada’s federal and provincial governments are among the most secure investments available. The security of bonds balances the volatility of stocks and mutual funds. This security becomes more important as you grow closer to retirement.
The easiest way to adjust the balance between growth and security is to match the percentage of your RRSP that is in guaranteed investments with your age. At age 25, 25 per cent or less of your RRSP can be in bonds. By age 50, generally half of your plan should be in these guaranteed investments, rising to 65 per cent at normal retirement age.
To protect against changes in interest rates, use a laddered strategy: Place 20 per cent of your guaranteed investments to mature in one year, another 20 per cent to guaranteed maturing in two years, and so on until the last 20 per cent matures in five years. Each year, “roll over” maturing investments to new ones paying the new interest rate. If interest rates are higher, one-fifth of your investments enjoy better growth. If interest rates have dropped, four-fifths of your investments keep earning the original higher rate.
Stock markets sometimes overreact to changing conditions and steep drops in prices are eventually followed by periods of recovery and growth. These fluctuations in the market should be of little concern to RRSP investors who remain focused on their long-term destination. To prepare your RRSP for detours and traffic jams, talk to a professional financial advisor about these and other investment strategies.
Paul Emerton is a Certified Financial Planner and Senior Training Specialist with FaithLife Financial.
The article above was featured in the March 2009 issue of SEVEN magazine.