When it comes to choosing an investment, sometimes your choice will depend on what stage of investing you are at. In this article I explore investing as a progression or evolution of how much money you have in your portfolio. Experience and timing can play a role in how your money is invested. If you think about it, the more money you have in your RRSPs, the more sophisticated you can get.
Stage 1: Single investment investing.
When you are just beginning to invest, you are likely to start small picking one or two investments at a particular institution. If you are conservative, you might invest in a single GIC. Otherwise, you could buy one or two mutual funds. Often a balanced fund is a great place to start because it offers investors the greatest diversification without having to have a significant amount of capital. Balanced funds offer a simple and easy risk/return tradeoff.
For example, Susan bought her first RRSP at the bank. She met with the financial advisor at the bank and was advised to put $1500 into the bank's balanced fund. The bank also suggested that Susan invest $250 per month to RRSPs instead of trying to do it at the end of the year. This is reasonable and common advice for first time investors.
Stage 2: Single company investing.
As your investment grows and you continue to add money to your portfolio, you are likely to increase the number of different investments but with the same financial institution.
If we follow along with Susan's journey, in addition to her monthly contributions to the balanced fund, she also made annual lump sum contributions to her RRSPs. Every year during RRSP season, she would go to the bank and invest a couple of thousand dollars but into a different fund than the balanced fund. One year, this annual deposit went into a Dividend Fund. In another year, this deposit went into a Global Equity Fund. There was one year she felt really aggressive and put some money into an Emerging market fund, while in another year she put the money into a Bond Fund. Susan went through 3 different financial advisors over 6 years and she got different investment ideas every year. After 6 years, Susan had close to $50,000 in her RRSPs. She now had all her money with one company but in a variety of different funds.
Stage 3: Multi company investing
At some point in time, some investors feel it's important to diversify, not just by having different types of investments but also with different institutions or advisors.
Susan was a little tired of dealing with different people at the bank all of the time. When she would compare stories with one of her friends at work, she was a little jealous that her good friend Elle was dealing with the same financial advisor for the past 6 years and developed a good relationship with that advisor. Susan agreed to meet with the advisor but was reluctant to move her whole portfolio (which was performing reasonably well). Instead, Susan agreed to stop the monthly contributions at the bank and re-direct them to the new advisor. The new advisor recommended 3 different funds at CI Mutual Funds. Susan now has two single company RRSPs which is also a common progression for investors.
Related article: The online guide to working with a financial advisor
According to my research, I believe that mutual funds are NOT created equal – there are good funds and there are bad funds. I also believe that every financial institution has good funds, bad funds and average funds. No single company has the corner on all the best products, nor the worst products. Thus, if you employ ‘single company' approach you are pretty much guaranteed to have a combination of good and bad investments. Yet, it is important for investors to go through this stage because it is difficult to get too sophisticated without a significant sum of money.
Stage 4: Self Directed RRSPs
I read somewhere that the average Canadian RRSP investor has something in the order of 2.4 plans. That's a bit odd, given that there are so many advantages to holding a single consolidated self-directed plan.
Once you reach a certain portfolio size, you should consider the benefits of a Self-Directed RRSP. The advantages are both practical and economical. On the practical side, you will have less paperwork, fewer statements and fewer tax receipts. You will also get a more complete picture of your overall portfolio.
On the economical side, a self-directed plan also makes sense. It can give investors access to a full-range of investments – not just one company's mutual funds but funds from all companies, individual stocks, T-bills, strip bonds, Canada Savings Bonds, GICs and whatever other choices are needed to achieve the optimal asset mix. It also allows for more efficient use and tracking of the foreign content.
Another important advantage to a self-directed RRSP is that it eases the conversion at age 71 (or sooner) to a self-directed Registered Retirement Income Fund (RRIF). Many of the advantages of a self-directed RRSP also apply to a self-directed RRIF, but the administrative advantages are more notable. Multiple RRIFs can complicate record keeping because RRIF rules require a minimum annual withdrawal from each RRIF. If someone has 3 RRIFs with different financial institutions, they have to deal with multiple income streams, multiple statements and tax slips, as well as manage the investments separately.. That can mean a lot of excess paperwork.
Related article: The Online Guide to RRIFs
The downside to Self-Directed Plans is they typically have a trustee fee ranging anywhere from $50 to $200 per year. Therefore it is important to reach a certain threshold before self-directing. You should avoid self-directing until you have $30,000 to $50,000 in RRSPs. There is no hard line amount but it is easier to justify the annual trustee fee at a certain threshold of assets. Consolidating your RRSP plans into a Self directed RRSP at some point will make sense. Everyone's situation is unique so be sure to weigh the pros and cons before you self-direct.
After about 9 years, Susan has amassed $90,000 in RRSPs. She felt more comfortable with independent financial advisor referred to her by her friend. After going through 2 more people at the bank, she decided to consolidate all her RRSPs and move it to the independent financial advisor. The financial advisor recommended that she utilize a self-directed approach and created a diversified investment strategy. Susan really likes the idea of only getting one statement and having an advisor pick and choose different investments from different companies. Susan reached a new stage of investing.
Related article: Advantages of Self-directed RRSPs
Stage 5: Wrap accounts and Private Wealth Management
There is an increasing amount of information on Wrap accounts and they have been promoted as the next step beyond mutual funds and Self-Directed Plans. Be very careful with these generalizations, as some wrap accounts are simply glorified “single company investment” plans. Many wrap accounts belong between stage 2 and 3 because you are still investing in a single company's product shelf. There are more wrap accounts being offered but most are more sizzle than substance. Watch the fees and make sure you take the time to understand the individual investments within the wrap product.
As you can see, many investors will go through different stages of investing depending on their circumstances. There is no perfect evolution. What stage of investing are you at?