It’s a classic mistake I’ve seen time and time again. You scramble to make your RRSP contribution before the deadline, then pat yourself on the back on a job well-done. But wait a minute. You’re not done yet. Not if your RRSP contribution is just sitting idly in cash. You need to put that money to work. Complete the process.
BlackRock’s annual Investor Pulse Survey shows that Canadians hold 60 percent of their portfolios in cash. The narrative here is usually about how Canadians are scared of the stock market and prefer safer cash savings and GICs.
If that’s the case then financial advisors are doing a terrible job explaining how long-term investment returns work. But I think there’s something else going on here:
- Too many Canadians believe that you “buy RRSPs” during RRSP season.
- Too many Canadians park their savings in cash because it’s liquid and convenient. Easy to raid for “emergencies” (and vacations).
You don’t “buy RRSPs”
Anecdotally several readers and clients told me that they’ve dutifully made their RRSP contributions but then failed to turn that contribution into a stock, bond, mutual fund, or ETF purchase.
Remember, you don’t actually “buy RRSPs”. Your RRSP is simply a container in which you can hold a wide variety of investments. It’s a two-step process. Make your RRSP contribution and then purchase the investment that aligns with the asset allocation outlined in your financial plan.
For example, let’s say you’re a couch potato investor and have decided to invest using a model portfolio made up of Vanguard’s Canada All Cap Index ETF (VCN), the Global All Cap ex Canada Index ETF (VXC), and the Canadian Aggregate Bond Index ETF (VAB). You’re most comfortable with a balanced portfolio made up of 40 percent bonds and 60 percent equities, therefore your asset allocation mix should look like this:
- VAB – 40 percent
- VCN – 20 percent
- VXC – 40 percent
In dollar terms, that means every $10,000 invested in your portfolio should look like this:
- VAB – $4,000
- VCN – $2,000
- VXC – $4,000
Shown this way the concept looks easy. But your regular ongoing contributions can muddy the waters. Where does your next $1,000 contribution go? Three separate transactions (buying $400 worth of VAB, $200 of VCN, and $400 of VXC) could cost you $30, so that doesn’t make much sense. But one transaction (buying $1,000 worth of one ETF) will throw your allocation out of balance.
The good news is that market forces take over and so the market value of your holdings will fluctuate up or down. This helps make your decision easier as you want to contribute to the ETF which is down the most (buy low) in order to bring it back into balance.
I’ll use my RESP as an example because it’s the account that I make regular monthly contributions to one of three TD e-Series funds (Canadian, U.S., and International), with the goal of maintaining an allocation of 33 percent for each fund. Each month I contribute $416.66 to the RESP (step one) and then manually purchase one of the three funds (step two).
After years the market value of each fund can vary widely, however as you can see below I’ve managed to do a decent job sticking to my original allocation mix:
The U.S. fund is up considerably over the last few years, which simply means I’ve purchased less units of this fund and sunk more contribution dollars into the Canadian and the International funds. But the chart shows that the portfolio today is very close to my desired allocation mix.
Stop Treating Your Retirement Account as a Slush Fund
The other problem I see with having too much cash in our portfolios is that we’re constantly raiding our RRSPs and TFSAs for short-term needs instead of using them for their intended long-term retirement purposes. Sure, there are legitimate reasons to withdraw money early from your RRSP, such as the Home Buyers’ Plan (maybe not), or cover a gap in employment or financial hardship.
But again, I think there’s something else going on here. How many Canadians make their RRSP contribution during RRSP season, simply because of the allure of a tax refund? They get the refund in April, then take the money out of their RRSP and spend it on a vacation, car, renovation, new TV, you name it.
We’re using our RRSP savings as a slush fund. Indeed, Canada Revenue Agency reports that 55 percent of total RRSP withdrawals in 2013 were made by Canadians under 60. That’s an alarming statistic!
By completing step two of the contribution process and actually purchasing a stock, mutual fund, or ETF you’ll not only get closer to your financial goals, but you’ll make it that much harder to raid your retirement fund for something frivolous. If your RRSP contribution is just sitting idly in cash, it’s much more tempting to move it back into your chequing account – which is a big no-no.