RRSP season is back again and for many that means putting some money aside for retirement. What’s the best place to put your money this year? What’s hot and what’s not? These are some common questions that are very difficult to answer. In this article we will try to tackle some of the issues you need to consider before you look at some of the various investments in the marketplace today.
1. How much risk are you willing to take?
Fundamentally, this is the best place to start when investing in RRSPs. Before you invest, you really need to try to understand how much risk you are willing to take. Now that we have gone through one of the worst bear markets in history, hopefully, we have a much better understanding of what risk really means.
Obviously, there is a wide range of investments that range from the lowest of risk to the highest of risk. What’s comfortable for you may not be comfortable for someone else. Make sure you start understanding your risk tolerance.
2. How long do you have to retirement?
Age, time and patience obviously play an equally significant role in determining what you should invest in. The younger you are and the more time you have until retirement, the more risk you can take. This gives you the opportunity to invest for growth and higher potential returns. For those that are closer to retirement, a more conservative philosophy may be prudent.
3. Are you a sophisticated investor?
They may opt for more traditional investment options. Some investors have a lot of time and energy to seek and learn about new investment ideas. These two extremes will have very different ideas of what makes a good investment. How much time, expertise, knowledge and passion do you have for investing?
4. What is your financial situation?
Some just starting out making their very first RRSP contribution will probably choose a very different investment than someone who has $500,000 already invested in a well diversified investment portfolio. Your overall financial picture will definitely skew your investment plan. Taxes, income, and assets all determine your financial stability.
5. What are your investment objectives?
Recognizing and prioritizing your investment objectives will impact your investment choices. What objective is most important to you? Are you looking for income from your investments? Is safety of capital your top concern? Are you trying to grow your portfolio aggressively for the long term? Or could you be the investor that looks for balance between safety and growth? Whatever the case may be, knowing your investment objectives before you buy an investment makes a lot of sense.
So this is the starting point. Make sure you take the time to ask yourself these questions and answer them as honestly as possible. Before you go out and research investments, you can save yourself a lot of time and grief by taking the time to understand you and your personal investment needs. Conservative investors who are approaching retirement in good financial shape may be better off avoiding risky investments no matter how appealing they might be. On the other end of the spectrum, a young, eagerly aggressive couple just starting their investment portfolio looking to grow a good long term retirement portfolio is more likely to look for some good quality equity funds instead of fixed income.
While these examples are generalizations, I hope you understand my point. Different investors will have different ideas of what a good investment means to them.
Far too often investors seek and buy investments without looking within and determining what kind of investment they need or want in the first place. It is imperative that you take the time to look at things like risk tolerance, time horizon, investment objectives, financial stability and investor knowledge which all play a role in matching investments to investment personalities
High Interest Bank Accounts
First we start with high interest bank accounts. Although most of these are designed for non-RRSP savings, many financial institutions now have RRSP eligible versions of the high interest bank account. Currently, these investments are paying 2.25% to 2.55% with little to no fees and high liquidity. Although 2.55% may not seem like a good return, relatively speaking it is the perfect solution for conservative investors or investors with a short term need.
Principal Protected Notes
Principal Protected Notes belong in a category of investments that I call ‘hybrid investments’. I call them hybrid investments because they have some characteristics of guaranteed investments and some characteristics of non-guaranteed investments. These notes are similar to a GIC in that you would invest for a term of 5 years for example and the invested capital would be 100% guaranteed. These investments are similar to non-guaranteed investments in that the future returns on the investment are variable. The returns are linked to a non-guaranteed portfolio like a stock market index, a mutual fund or hedge funds. Many have termed protected notes, the best of both worlds.
Real Return Bonds (RRBs)
With interest rates at historical lows, there is more talk and pressure for rates to increase rather than decrease. This will put conventional bonds in a tough spot moving forward in the years ahead. As a result, if you still need fixed income in your portfolio, take a look at Real Return Bonds. They are typically government bonds that offer an added inflation premium. RRBs will be one of the best types of bonds in inflationary periods. One of the best ways to get a diversified holding of Real Return Bonds is through the TD Real Return Bond Fund.
Open Mandate Funds
What are open mandate funds? Every mutual fund has a mandate that managers need to follow. For example, a Japanese Equity fund would mandate the fund manager to buy Japanese stocks. Chances are they could not buy US Equities, as that would not be in the mandate. Part of the mandate is to place restrictions on how much of the portfolio can be invested into cash or fixed income. These parameters can be restrictive. An open mandate fund is simply one with fewer restrictions. I believe that if you can find a good manager, give them the opportunity to make money and protect capital using their expertise. One example of an open mandate fund it the Fidelity Northstar Fund run by Alan Radlo.
Adding hedge funds to a portfolio can be one of the best diversification moves. Studies have shown that adding a 10% to 25% exposure in a portfolio to Hedge Funds or Alternative assets can dramatically reduce portfolio risk. Generally, hedge funds are not highly correlated to stock markets. This low correlation is the primary contributor to efficient asset allocation in the efficient frontier. The bottom line is choosing hedge funds can be a daunting task on its own, so if you are confused about how to add hedge funds to your portfolio, consult a financial advisor.