The first 60 days of every year is known as RRSP season. March 1 is the RRSP deadline when Canadians can make contributions to an RRSP and have it eligible for a tax deduction for the previous year. So what happens when March 1st comes and goes?
While your mind is thinking about RRSPs and the benefits of saving taxes, it may be the opportune time to think ahead and start planning for next year’s RRSP.
Invest your tax refund into RRSPs
For some, a tax refund is kind of like winning a little lottery – bonus money! Try hard to resist blowing your tax refund and instead consider taking that tax refund and investing it directly in the RRSP for the following year. You’ve got to do it fast so you do not even miss it. Next year at this time, you’ll be happy that you did it early!
Keep contributing after the RRSP loan is paid off
If you take out a RRSP loan, consider keeping your monthly payments the same once the loan is paid off; only direct it as a contribution to your RRSP. If we have a payment, psychologically, we are more likely to prioritize that expense higher than a contribution to an investment. Treat your contributions like a loan payment.
Contribute to RRSPs monthly
The best way to contribute to a RRSP is to not worry about the deadline and invest directly into the RRSP on a monthly basis automatically. Studies have shown that those Canadians that contribute to a RRSP monthly tend to have more money in their RRSPs over the long term than those that contribute annually at the deadline.
There are many benefits to monthly contributions to an RRSP but the most important benefit is the forced savings discipline that it creates. There are many other benefits to investing in RRSPs on a regular basis:
- Forced Savings. Automatic monthly contributions to your RRSP create a forced savings discipline and it is discipline that is the difference between success and failure. Far too often people spend first and save what little they have left. Studies have shown that saving first is a habit of wealthier people. With a forced savings plan, you are more likely to save more money than someone without a forced savings plan.
- Lowering your averaging cost (Dollar Cost Averaging). Investing into non-guaranteed investments on a monthly basis is advantageous because it helps to systematically smooth the highs and the lows of the markets. In fact dollar cost averaging forces you to buy more units when the price is low and less units when the price is high. The end result is dollar cost averaging lowers the average cost of the investment.
Let’s say you have $1,000 a month to invest. If in the first month, the price were $10 per share, then the $1000 would buy 100 units. Let’s say the next month, the share price doubles to $20. Psychologically, you would be very happy and you would want to buy more and more. However, empirically, your $1000 would in fact buy only 50 units of the same share.
Month Money Invested # of Mutual Fund Units Purchased Cost per Mutual Fund Unit January $1,000 100 $10 February $1,000 50 $20 Total $2,000 150 $13.33
Put simply, dollar-cost averaging helps you come out ahead over the long term. The average price for the investment over the 2 months is $15 but the average cost to you is only $13.33 because you bought more units when the investment was cheaper and represented better value.
- Reduces timing risk. In the example above, dollar cost averaging has the added benefit of helping you to remove emotional and psychological mistakes when it comes to investing. When prices are rising and your portfolio value is increasing, it is human nature to want to keep and ride your winners. In fact, if your portfolio contains five winners and 2 losers, it is human nature to sell your losers to buy your winners. Yet, logically, we know we are supposed to buy low and sell high.
Dollar cost averaging helps you reduce the risk of bad timing by removing emotions and lessens the risk of investing a large amount in a single investment at the wrong time.
So there you have it. Some very compelling arguments as to why RRSP season really starts today for the next tax year. Get started now because there is no time like the present. Start up a monthly savings plan to help ensure that you stay on track with systematic savings.