The article “Take Back Control Of Your RRSP With These Three Easy Steps” was originally published on Financial Post on January 31, 2018.
Make sure you know what you own, what you pay and what your returns are in order to work toward your retirement goals
If you’re like most Canadians, you probably don’t have all the answers when it comes to registered retirement savings plans. But that’s no reason to neglect one of the most significant savings vehicles available to you. With that in mind, here are three basic steps that can help any investor take back control of their RRSP. For those who are further along, I’ve also included some pro tips to help you maximize your savings.
Step 1: Know what you own
Approximately one-third of RRSP assets are invested in mutual funds according to the Investment Funds Institute of Canada (IFIC). From experience, I can tell you that many investors are unclear on exactly what they own in their accounts. This uncertainty is magnified by the names of many financial products, meant more for marketing than clarity.
An “income fund” sounds safe, but may have a high allocation to stocks. And not all investors realize that bonds can go down in value as interest rates rise. Even a “growth fund” can shrink significantly in a market downturn, often more so than broader stock markets.
I think it is critical for an investor to know what type of financial products they own and what is their overall asset allocation between bonds and stocks. If you have not discussed risk tolerance and determined a target long-term return to meet your retirement objectives with your advisor, this should also be a priority this RRSP season.
Pro tip: Did you know if you own Canadian mutual funds, exchange-traded funds (ETFs) or pooled funds that invest in U.S. stocks in your RRSP, your RRSP is subject to tax? This is because the tax treaty between Canada and the U.S. requires 15 per cent withholding tax on dividends paid to residents of the other country. Canadian resident mutual funds, ETFs and pooled funds therefore have 15 per cent withholding tax on dividends and only receive 85 per cent of any dividends paid by the underlying U.S. stocks. If you own U.S. listed stocks or ETFs directly in your RRSP, your RRSP has a special exemption to this withholding tax, meaning you get 100 per cent of your U.S. stock dividend income.
Step 2: Know what you pay
The financial industry experienced wide-ranging regulatory changes in 2017 resulting from the implementation of Client Relationship Model II. CRM2 requires two new reports for investors on their statements to summarize “money-weighted” investment returns as well as some (but not all) of the fees paid for investments.
According to the 2017 Canadian Securities Administrators (CSA) Investor Index Study conducted in September, the new information disclosed because of CRM2 led an astonishing 44 per cent of investors to make changes to their investment products, fee arrangement, advisor or firm. If you did not make changes yourself, hopefully it is because your fees were reasonable in the first place and not just due to complacency.
Unfortunately, CRM2 only tells part of the story on fees. For mutual fund investors, their new statement discloses only trailer fees paid to their advisor. This trailer may only be 0.75-1 per cent per year, but the total management expense ratio (MER) paid to own a mutual fund might be more like 2-2.5 per cent. The new disclosure only explicitly states the trailer fees, which can be less than 50 per cent of the overall fees to own a mutual fund. And certain funds, called segregated funds, require no such disclosure at all.
For some rough rules of thumb on what is a fair fee, I will suggest the following. The average mutual fund MER in Canada is currently about 2 per cent, but varies depending on the type of fund (less for a bond fund and more for a foreign stock fund). Regardless of your account size, there are more and more alternatives to mainstream retail mutual funds.
Low-cost wholesale mutual funds may have MERs in the 1-1.5 per cent range. If you are in a fee-based account, 1-2 per cent is typical with larger accounts benefitting from lower fees. The all-in fee for a robo-advisor if you include both management and underlying ETF MERs is typically 0.5-0.75 per cent. And as a do-it-yourself investor, your fees can be virtually nil, but sometimes there is an indirect cost to going DIY if you forfeit investment strategy, discipline or financial planning.
Pro tip: If you are a DIY investor focused on fee minimization, Questrade offers the lowest basic online trading commission currently at 1 cent per share with a $4.95 minimum and $9.95 maximum. If you are a DIY ETF investor, consider National Bank Direct Brokerage, Qtrade Investor or Scotia iTrade, all of which offer commission-free ETFs for purchase and sale. If you are in accumulation mode and buying, but not selling, Questrade and Virtual Brokers offer commission-free ETFs for purchase, but charge commissions to sell.
Step 3: Know your returns
CRM2 has increased visibility of investment returns. But it is still difficult to assess what your personal return means. Your absolute return is nice to know, but what about relative returns? If you were invested 100 per cent in Canadian stocks, the Toronto Stock Exchange might be a reasonable benchmark to assess your relative performance. And while a 7 per cent return in 2017 might sound good without a frame of reference, the total return for the TSX including dividends was 9 per cent last year. That return may therefore be a fair relative benchmark for 2017 for an all-Canadian stock portfolio. Not that one year is a long enough time period to adequately assess returns, but you get the idea.
Since most accounts include a mix of cash, bonds, Canadian and foreign stocks, how did your account perform relative to a personally representative benchmark?
While relative returns and “beating the market” are important, as a retirement planner, I am primarily concerned that an investor has a sense of their actual historic and potential future investment returns. If someone needs a 5 per cent return to achieve their retirement objectives, but they are invested in GICs, something has got to give.
Pro tip: Everyone wants to earn high investment returns. But be careful how and where you earn those returns. Given the chance to grow a large RRSP or a large TFSA, which would you choose? The answer should be a large TFSA, where your eventual withdrawals are tax-free, instead of your RRSP, where your eventual withdrawals are taxable. Try to ensure an asset allocation whereby your growth investments are in your TFSA and your conservative investments, if part of your overall asset allocation, are in your RRSP. And when you retire, even if you are in your 50s or 60s, you should strongly consider early RRSP withdrawals, even if you do not need the funds. Slowly drawing down your RRSP over time may allow you to smooth your income over the balance of your life and pay less lifetime tax as a result.
Conclusion
Knowing what you own, knowing what you are paying in fees and knowing what you are earning in returns should be goals for anyone looking to take control of their RRSP. These are factors that an investor can control, regardless of all the things that happen in the markets that are beyond control.
Success is always a process and financial success is more than just saving money. To become financially independent, you need to understand your investments and ways to improve them. Unfortunately, the financial industry does not always have your best interest at heart. Seek out people who do, but know that ultimately, your own financial knowledge will best ensure your best interests are represented.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.
