Seven tips to build a fat RRSP nest egg
We’ve all heard it before. The biggest enemy to your financial future is you. This of course is true. I’ve learned to appreciate this fact more than fiction because of my own investing experiences. I used to tinker with investments in my Registered Retirement Savings Plan (RRSP) in my 20s. Chase this hot mutual fund; chase that one. I always felt like I was playing catch-up when it came to fund performance (and I was).
Over the years things have changed for me – big time.
I learned more about investing and my behaviours related to market swings, so I’ve been able to rid myself of very poor investing habits. Staying out of my own way is just one way to build a fat RRSP nest egg.
Here are six more tips.
1. Focus long-term
Investing is not a race and it’s not a fad. The very definition of an investment is an asset purchased with the hope it will generate income or appreciate in value in the future, so from an economic sense, assets are not used today. This is why time in the market is your friend. Use the RRSP and select assets for this account to hold long-term.
2. Select enough equities to marry your risk tolerance
Over long-term periods of investing, stocks generate higher returns than bonds and bonds generate higher returns than cash under your mattress. The higher the allocation to equities, for longer, the better your returns should be. That said you may want to temper your equity exposure to less than 100% because bull markets tend to make investors feel far more confident than they really are; Mr. Market has a way of exposing bad investor behaviour by making you sell assets at the wrong time.
3. Save and then consider saving some more
Although rates of return are important your savings rate is a huge factor when it comes to financial wealth. Take this quick example:
John saves a little bit every month. John is 30 years old. John has $25,000 in his RRSP and contributes $300 per month to it. Assuming John has all stocks in his RRSP, and his portfolio returns about 7% on average for the next 30 years, John’s RRSP portfolio value will be a tidy $554,000.
Suzie the saver pays herself first every month and is diligent at it. Suzie is also 30 years old and has the same $25,000 accumulated in her RRSP. Unlike John, Suzie contributes $600 per month to her RRSP account. Suzie is much more conservative though with her portfolio, she will hold 50% bonds for the next 30 years. Although John’s returns are 2% more every year for 30 years than Suzie’s, Suzie will come out ahead of John thanks to her aggressive and larger savings rate. Suzie’s portfolio value will be close to $610,000 at age 60.
Consider saving enough every year to max out this account if you’re in a high tax bracket.
4. Consider rebalancing during “RRSP season”
Not sure when to rebalance your portfolio? Keep it simple. Consider rebalancing your portfolio once per year during “RRSP season” sometime between early February and early March. You won’t forget to do it at this time of year because there will be thousands of financial ads to remind you about your contributions to this account.
5. Use mostly indexed products
I suggest you do this certainly if you don’t want to invest in a number of individual stocks like I do. Even then, I’m a hybrid investor, I own a few low-cost ETFs and I hold a number of Canadian and U.S. dividend paying stocks. I’m indexing more going-forward to become more diversified. Diversification just makes sense. Besides, forget me, you should probably listen to Warren Buffett (as told to investors in his 2013 letter to Berkshire shareholders, when referring to his estate plan):
“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”
6. Don’t raid the nest
This point probably needs no further elaboration maybe only to say spending too much money today, including any borrowed funds from your RRSP because you YOLO (You Only Live Once), is borrowing from your future self. I continue to thank my friend Preet Banerjee for instilling this thought into me.
Wait, you might say, there’s the Home Buyers’ Plan and this doesn’t count! I’m not a fan of this program friends. A house is a house, something you live in and hopefully it will appreciate in value over time. An RRSP is a retirement account. House rich but asset poor is not good diversification. Besides, when did home ownership become more important than retirement savings? These are not the same things.
RRSP power comes from a tax deduction for your RRSP contribution and tax-deferred growth. For Canadians who expect to be in a lower tax bracket in retirement versus their contribution years this account has lots of firepower to help you build a fat retirement nest egg.
What considerations did I miss for building a fat RRSP nest egg?