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RRSP Strategies Part 3: Keep it Safe to Start. Use Cash, Bonds, and GICs to Build Your RRSP Base

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Many investors aren’t going to want to read this, much less act on it, but I think the first thing you need in your RRSP is a safe base. This is the so-called fixed income or guaranteed part of your holdings. The money should be invested in boring, probably low-interest, (almost) totally safe options. These include cash, bonds, term deposits and GICs. For the really adventurous it could include money market funds and T bill funds. These are dull, predictable investments that you would likely be embarrassed to mention at a party. These are the investments, though, that will see you safely through many investing storms ahead.

How Much Money Needs to Be in the Safe Base for a RRSP Account?

Some of you are likely itching to get past the “safe” investments and move into the glitz and glamour of investing in stocks, options and hedging. You may be asking “How much do I have to have in ‘safe’ investments before I can move on?”

There is no right or wrong answer.

Personally, I would suggest having $25,000-$50,000 in safe investments before putting money into riskier ones. It’s very calming when the markets are bouncing around like lawn chairs in a flatbed truck on a washboarded road to know that a large chunk of your money is figuratively buried in the back yard perfectly safe and sound.

The gap between $25k and $50k yawns wide. How should you pick which side you need to stand on? Here are some factors to consider:

Do you have a maxed out TFSA? If so, how much is in it? How secure are the investments in it? If you have $31 000 $25,500 in cash and GICs in a TFSA (perhaps waiting to buy your next car or deal with any emergencies) then you probably only need $25,000 in safe investments in your RRSP before you lift the rope and cross into the deep end of the pool.
Also, how far from the shallow end are you planning to swim?

  • If you’re planning to invest in dividend-paying blue-chip stocks you can probably take those first strokes into the deep end while you have a fairly small safe base. Examples of the types of stocks I mean are shares in TD (a bank) or FTS (a utility company).
  • If you’re planning to try to pick individual stocks that will double in value in 6 months, you should have a substantial safe base. Examples of the types of stocks I mean are shares in BB (a high tech stock) or small aggressive oil and mining stocks.
  • If you’re planning to go for penny stocks, hedging, options, or leveraged investments you shouldn’t really be reading my blog. But if you are, consider having enough invested in total safety to buy you an annuity you can live on (at least spartanly) if all of your other investments fail.

Why is Losing Money by Investing Poorly When You Are Starting as an Investor So Serious?

The” You’re Young You Can Bounce Back from a Loss” Argument is Severely Flawed

So you are a new investor and you lost $2000. Why is that so bad? Yes, it hurts. But if you are a young new investor, you have many years to earn more money and hopefully make up the loss. That’s the logic used by many investment advisors who push their new clients towards high risk and volatile investments. (They’ll also push older new investors in the same direction but are a bit more wary of lawsuits.)

The problem is that many new investors who lose what feels like a lot of money will decide never to invest in that type of investment again. Ever. So if they buy a mutual fund that loses 40% of its value, they may never buy another mutual fund: not even an ultra-low-risk bond fund. And if they buy a stock that drops 25%, they may never invest in shares again. Even if they lost money on a hot tech stock they may refuse to buy even blue-chip dividend-paying stocks in the future.

Back when the dinosaurs roamed, I bought some index mutual funds in my RRSP. (There were no ETFs then.) They appeared to lose 25% of their value within the first 2 years. From then on I bought GICs for a very long time. Luckily I held on to the mutual funds. Eventually they evened out to earning about 7% a year over the long term. Still, it left me with a long-lasting reluctance to invest in the stock market, even by index investing.

Invest in Risk with Your Vacation Money Not Your Rent

One of my children was watching me update my financial spreadsheet with some dividend payments and capital gains one day. She was intrigued by the daily stock price chart shown on the brokerage account screen. So I stopped to let her really look at it.

“You know how you have money in the bank earning interest, right?” I asked. (She had it in one of the few accounts that actually paid interest: a 2% children’s savings account at ING Direct.) She nodded. “And you know you get $2 a year on every $100 in your account, right?” She didn’t but she nodded anyway.

“Well, if you look at this graph, you can see if you bought a share in TD this morning for $60, this afternoon it would be worth almost $62. So you could have sold it and made $2 profit on $60, not on $100. And it only took one afternoon, not one year.” Her eyes got bigger.

I flipped to the monthly stock price view.

“And if you bought the share last month for $55, you could have made $7 in one month.”
I flipped to the five year stock price view.

“But, uh oh, if you’d bought the share here” I pointed to 2008, “then sold it at this time here” I pointed to mid-2009, you would have LOST $30.

“That’s why you don’t want to put all of your money into stocks. Your Dad and I keep the money to pay for our house and food and the TV and the telephone in the bank. We only put the extra money, like for vacations, into stocks. Because it would be really sad if we couldn’t go on vacation and we’d be upset. But we would still have somewhere to live and something to eat and something to do. You should only risk the money you can afford to lose.”

And she got it. Whether she will make good choices when she’s old enough to control her own investments remains to be seen. But she did see that stocks are not safe investments and that only extra money should be put at risk.

Of Course I’ll be Safe: I Only Invest in Huge Blue Chip Dividend Paying Stocks

Can you say “Nortel?”

No company is immune from sudden, catastrophic failure.

Nortel, for those of you too young to remember was Canada’s bluest chip tech company with worldwide assets and employees. In mid-2000 shares were trading at $124.50 on the TSX. By 2002 it was worth less than $1 a share and was de-listed.

If you don’t believe it can happen again, search the history of Enron, WorldCom, Bre-X, Lehman Brothers, GMC, Chrysler and many more.

Dividend paying stocks do have a Secret Weapon that helps when the markets tumble. That helps make them lower risk than many non-dividend paying stocks. And dividend payers are usually older more established companies which may also make them safer investments. But you still need to have a truly safe base for your RRSP if you want to sleep easily.

What Kind of Investments Should Make Up the Safe Secure Fixed Income Part of Your RRSP

Cash
This is obviously a safe choice. Almost anywhere you invest your cash it will be covered by CDIC insurance up to a maximum of $100,000 per account. Make sure your cash will earn some interest, however. ING Direct, for example, offers a no-fee RRSP daily interest savings account.

Most discount brokerages do not offer ANY interest on cash balances at the time this was written. At some brokerages like CIBC Investor’s Edge you can get around this by buying no-fee mutual fund shares in a daily high interest account. (Please see ATL5000 High Interest Savings Account Fund at CIBC Investor’s Edge Online Discount Brokerage) At other brokerages like BMO InvestorLine you can’t unless you lock in $5,000 or more. (Please see Investing in AAT770. )

Guaranteed Investment Certificates (GICs)
Like cash, GICs offer a totally safe investment. They are insured by CDIC up to $100,000 if their term-to-maturity is 5 years or fewer.

GICs are often dismissed by financial advisors in recent years because the interest rate on a 1-year term is about 1.7-2% a year at the time this was written. Interest rates, however, have never been this low for this long. In 1991, I was earning over 10% interest on 1-year RRSP GICs offered by BMO. Not a bad return considering the investment was 100% insured and at no risk.

Boomer and Echo reviewed an insightful book by David Trahair in their article: Can You Succeed with an All GIC Portfolio? It’s worth reading. Did you know over the last 40 years, GICs have earned about 7% on average?

While I’m not advocating you invest only in GICs I am saying that having part of your safe secure base invested in GICs is worthwhile.

One caution when investing in GICs: Most GICs are not cashable. You cannot redeem them early. So if you suddenly need the cash they represent, you can be out of luck. You have to wait till they mature to get access to their cash value. If you might need access to your cash quickly, consider one of the other investment types.

You can buy RRSP GICs at almost any bank or credit union. The usual minimum purchase is between $500 and $1000.

You can buy GICs issued by a wide variety of financial institutions within self directed brokerage accounts. Usually the interest rates are higher than those offered directly at banks. The usual minimum purchase is $5000 per GIC.

Money Market Funds
Like GICs, the interest rates paid by money market funds have been hit hard over the past few years. Personally, I would not advocate investing in them right now when you could earn the same interest or more by investing in a daily interest account or GICs. Money market funds are not totally safe. They can lose money. And you have to pay a fee (a MER) which is deducted from the value of the fund before you are paid any earnings from the fund.

Term Deposits
Term deposits are very similar to GICs but are usually cashable after a certain period of time, often 30 days. Consequently, they usually pay a lower interest rate. They may require a larger initial investment.

T Bill Funds
These funds invest in government T bills only. They are very secure, however right now the rates paid by these funds are very low.

Bonds and Bond Funds and Bond ETFs
These are actually one of the riskiest investments for the safe and secure part of your RRSP. So in defiance of alphabetical order I’m placing them at the end of the list.

Buying individual bonds is difficult and can be costly. Most brokerages offer bonds for sale. The fee or commission is built into the price of the bond. That can make it difficult to compare different bonds. The face value of many bonds is also high which requires you to invest a lot in a single bond.

Bond funds make investing in bonds easier. You can let an experienced team pick and choose the best bonds. They have the buying power to negotiate the amount of commission they pay. And you can liquidate your holdings much more quickly and easily.

That said some of the best bond funds require a large initial investment. To buy PH&N funds through a discount brokerage you must buy a minimum of $5000 of a fund. There are annual fees charged by the bond mutual funds. Check these MERs carefully before making any purchases.

Bonds and bond funds may drop significantly in value if interest rates rise. People have been predicting this rise in interest rates and fall in bond values for several years now. One of these months it will actually start to happen.

[UPDATE: There are, of course, bond ETFs that like mutual funds invest in a variety of bonds. Unlike mutual funds, you buy and sell units of an ETF on the stock market like shares in a company. You usually have to pay a commission for each sale and for most purchases. Bond ETFs also have management expenses, MERs, but they may be lower than the annual fees for mutual funds. If you read about couch potato investing, you will find descriptions of commonly purchased bond ETFs.]

[UPDATE: in 2014 the US government has stated it will begin to stop “quantitative easing.” This may lead to a sharp increase in interest rates and a sharp fall in bond values. You should discuss the risks of investing in bonds with your financial advisor. Depending on your risk profile you may decide not to invest in bonds at this time. Personally I still have  money in bonds but I am expecting to suffer losses of up to 10-15% over the next few years.]

Concluding Recommendations for Building a Safe Secure Base for your RRSP Portfolio

In conclusion I would recommend

  • Invest at least $25,000 in truly safe and secure RRSP investments.
  • Invest in 1-2 year term GICs while rates are low and flat. Do not lock in to long terms at low rates.
  • If you invest in bonds, consider investing in a bond fund.
  • If you invest in a bond fund, to reduce the risk of losses, choose one with a short average term to maturity, such as the PH&N Short Term Bond and Mortgage Fund. (NOTE: The value and security offered by this fund may have changed by the time you read this article. Always fully research any investment suggestion before buying it. I’m not great at picking the winners!)
  • As your RRSP’s value increases, keep increasing the size of the safe and secure base. You want to end up with an investment pyramid built on a wide sturdy secure base, not an inverted pyramid balancing a top-heavy load of high-risk investments over a pinpoint of safe secure cash!

Further Reading

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Do you have your RRSP anchored with a firm safe base? What proportion of your RRSP is in safe fixed income investments? Please share your experiences with a comment.

RRSP Strategies Part 2 Move the Money Where You Want to Keep It. Choosing a Long Term RRSP Investment Account

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If you had to rush to contribute to a RRSP to meet the tax deadline, you may have parked your contribution temporarily at an institution that has no or a low transfer-out fee. Or, you may have decided to set up your RRSP account where you want to keep it before making any contributions. Either way, this article will discuss where you might want to host your RRSP account for the long term.

It’s important to understand that an RRSP is just an empty file folder. Inside the folder you can hold cash, guaranteed investment certificates (GICs), term deposits, mutual funds, exchange traded funds (ETFs), bonds, shares, and other investments.

Some financial institutions will offer you an RRSP folder that can only hold a few types of investments.

  • Many banks, for example, only allow your RRSP to hold cash, GICs, term deposits and mutual funds.
  • Most online self directed brokerage accounts allow you to hold almost everything possible in your RRSP.

Here are some factors to consider when choosing where to set up your RRSP account.

Convenience
Many people set up a RRSP account at the financial institution (bank, credit union etc) closest to where they live or work. Given that you can make a contribution to almost every RRSP by mail, computer or telephone, this does not seem like a great strategy. Unless the RRSP that location offers is the one that meets all of your other needs, I’d suggest you be prepared to be (slightly) inconvenienced in order to save money on fees or to earn more money within your RRSP.

Contributions
Others pick a RRSP account offered by the financial institution with whom they do their regular banking like paying bills and depositing pay cheques. This does make it very convenient to make new contributions to your RRSP. However, most financial institutions can now accept new RRSP contributions electronically so this convenience should not be a huge factor in your decision.

For example, at the time this was written [in 2013], RBC Direct Investing was offering a self directed RRSP brokerage account with no annual fee and no annual minimum balance if you set up contributions of at least $100/month to your RRSP. These contributions do NOT have to come from an RBC bank account. They can be set up using the bill payment option available from most banks. (For further information, please skim RBC Direct Investing has a No Annual Fee RRSP Brokerage Account with No Minimum Balance!)

Investment Choices
There are basically two types of RRSPs you have to choose between:

  • Bank RRSPs which limit you to cash, term deposits, GICs, mutual funds and possibly some ETFs. These investments are usually all issued by that bank. For example, you can’t purchase a TD e-series fund from within your BMO RRSP.
  • Brokerage RRSPs which allow you to invest in cash, term deposits, GICs, mutual funds, ETFs and shares issued by a wide variety of banks and financial institutions and traded on various stock exchanges.

Many people start with a Bank RRSP. When they have accumulated a large amount of money (often $25,000-$50,000) they then move it to a Brokerage RRSP.

Costs, Fees and Commissions
The costs, fees and commissions charged to host a RRSP account are a very important consideration when setting up a RRSP. Most of these costs must be paid from within the RRSP, reducing your retirement savings. (For example, if you have to pay $200 in fees per year from within your RRSP you have lost the ability of that money to earn income from now till the year you retire. And yet you cannot contribute any more money to your RRSP to make up for it if you have already maximized your contributions to your RRSP.)

Typical costs include

  • A quarterly fee for a RRSP account whose balance is less than a minimum amount of dollars. Most banks do not have any minimum balance requirement and charge no fee. Most brokerages do have a minimum balance requirement or they do charge a fee. (Please see RBC Direct Investing has a No Annual Fee RRSP Brokerage Account with No Minimum Balance! and Questrade Has the Lowest Annual Fee RRSP Brokerage Account With No Minimum Balance: Or Does It? for details.)
  • A cost to purchase or sell shares and ETFs. These types of investments can be purchased within RRSPs provided by brokerages. For most bank brokerages, the cost to purchase or sell depends on the total value of your RRSP account. Generally, the more money you have in your account, the lower the trading cost. For example, if you have $50,000 or more, at BMO InvestorLine, CIBC Investor’s Edge, RBC Direct Investing, ScotiaBank iTrade, and TD Waterhouse [now TD Direct Investing in 2014] you’ll pay $9.95-$9.99 per trade.
    (A trade is one completed request to purchase or sell one type of stock or ETF on one day.)
    The trading costs can be lower at independent brokerages. For example, Questrade charges $4.95 for most trades regardless of the account balance.
    UPDATE FEBRUARY 2014: Both RBC Direct Investing and TD Direct Investing have suddenly dropped their trading commission to $9.95 per trade (or less) for all investors regardless of their account balance.
  • It looks like you are not paying a fee when buying a bond. In reality, the fee is already included in the purchase price. The fee is set by the financial institution selling the bond. It is very difficult to easily determine whether one brokerage is offering a higher or lower fee to purchase a bond than another brokerage. I ignored bonds when choosing where to invest. Bond funds are a type of mutual fund or ETF and the usual fees and constraints for purchasing other types of mutual funds and ETFs apply.

Less common costs include

An inactivity fee for a RRSP where the investments are not being changed. (At the time of writing I am only aware of Questrade charging such a fee. It only applies to accounts with balances of fewer than $5000 held by persons aged 26 and older.)

Free Transactions

Most discount brokerages and financial institutions allow you to purchase GICs and term deposits for no fee. Banks and credit unions, however, usually only let you buy these products when they are issued by themselves which may reduce the interest rate you can earn.

For example, if I buy a GIC from BMO InvestorLine I can buy one issued by over a dozen companies. If I buy one from BMO, I can only buy a BMO GIC. Today, I could get a one-year term for 1.7% from Home Trust via InvestorLine. If I buy a GIC today at BMO, the best 1-year rate I can get is about 1.3%.

Most financial institutions only allow you to purchase mutual funds they issue. Those funds may not offer what you want, or they may have high MERs.

A MER is a fee you pay for owning the fund BEFORE the fund pays you any profits. So if the fund makes 5% profit for a year, and the MER is 2.5%, you only make 2.5% profit for the year. If the fund makes 2% profit for a year, and the MER is 2.5%, you actually lose 0.5% of your fund’s value that year! NOTE most sales brochures quote the performance of the fund AFTER the MER is subtracted. So if it says it earned 7% last year, then it really earned (7+MER)%, perhaps 9.5%, last year.

Most discount brokerages allow you to purchase a wide variety of mutual funds issued by many institutions for no fee. They often set required minimum purchases, however. For example, at BMO InvestorLine you are required to buy at least $1000 of a non-BMO mutual fund for a first purchase, and at least $500 at a time for each additional purchase of that same fund.

Transferring to a Self Directed RRSP Brokerage Account in the Future

If you don’t start with a self-directed brokerage account, you may want to position yourself for a future transfer to one. There is usually no fee to transfer a RRSP account from a bank to its corresponding brokerage. For example, there is no fee to transfer a RRSP account from BMO to InvestorLine or from CIBC to Investor’s Edge.

If you think you want to start with a bank RRSP and then transfer later to a brokerage, you may want to choose the bank that matches the brokerage you ultimately want.

Some brokerages, by the way, will pay the transfer fee for you if you are bringing in a large enough account. Usually they want you to be bringing $50,000 or more before they will pay your transfer fee.

Transferring Your Parked RRSP Contribution to your Permanent RRSP

If you parked your RRSP contribution in a daily interest savings account at ING Direct, or elsewhere, it is fairly easy to transfer it to your permanent RRSP.

Ask the provider of your permanent RRSP to supply you with the T2033 form to transfer the money. On this transfer form you will

  • provide the name and address of the place where the money is now (e.g. the address for ING Direct).
  • provide your account number and information about the current balance of the account
  • fill in the name and address and account number of your new RRSP

You often have to attach a photocopy of a recent statement from your existing RRSP.

The form and photocopy are mailed to the financial institution that is holding your current account. For example, either you or your bank/brokerage would mail the form to ING Direct if they have your cash RRSP. After 2-8 weeks, they will electronically transfer the money to your new permanent RRSP.

Can I Transfer my RRSP GICs to my RRSP Brokerage Account?

You usually cannot transfer GICs from one RRSP to another. Also, you cannot cash GICs until they mature. If your investments are in GICs, you will have to set instructions to have the GICs mature to a RRSP daily interest savings account. Once they are in the cash account, you can easily transfer them.

Can I Transfer RRSP Mutual Funds to my RRSP Brokerage Account?

It depends. Specifically it depends on whether the broker sells the type of mutual fund you want to transfer. For example, I was able to transfer some BMO RRSP mutual funds to my InvestorLine account. I could also transfer some CIBC RRSP mutual funds to my Investor’s Edge account. However, neither BMO nor CIBC offers ING Streetwise funds for sale. So it would not be possible to transfer Streetwise funds to their brokerages.

If you want to transfer RRSP mutual funds, you should call your brokerage to discuss whether it is possible. If you have not yet picked a brokerage, you might want to call and ask before setting up an account. Perhaps one brokerage would be better than another for this purpose.

My Recommended Strategy for Setting Up a Long Term RRSP Account

Strategy for RRSP Accounts of Fewer than $15,000 for Several Years

If you expect to have less than $15,000 in your RRSP for several years, I would recommend setting up your RRSP account with a bank or financial institution. (Please see RRSP Strategies Part 3: Keep It Safe to Start.)

I would choose the bank that offers the best mutual funds and/or ETFs for my current needs.

Most of them could meet those criteria, so next I would choose the bank that is affiliated with the self directed brokerage I am most likely to want to use in the future. This will save an account transfer fee in the future.

Bank Brokerage
BMO InvestorLine
CIBC Investor’s Edge
RBC Direct Investing
Scotia iTrade
TD Waterhouse [now, in 2014 “Direct Investing”]

Generally if you have a balance of $25,000 or more you can get an independent brokerage like Questrade to pay your account transfer fees. So if you choose a potential bank brokerage today and change your mind to an independent brokerage when the time actually comes to make the shift it should be fine.

One choice you should thoroughly research is the TD BASIC SDRSP (which means self directed retirement savings plan). It is sort-of a step between a bank RRSP and a brokerage RRSP account. It allows you to invest in very low MER e-series TD funds. (For details, you might want to read an article by the Canadian Couch Potato about this plan.

Another choice to take a close look at if you have at least $10,000 is the RBC Direct Investing self directed RRSP. If you are willing to commit to pre-authorized contributions every month it is fee-free and gives a wide range of investment choices. (You generally need a large balance to buy GICs within a self directed plan. InvestorLine, for example, requires you to buy GICs with a minimum size of $5000 each.)

Strategy for RRSP Accounts of More than $25,000

If you already have $25,000 in your RRSP I would start researching self directed brokerage RRSP accounts and pick one and set it up immediately. It will increase your investment flexibility without any significant drawbacks. You can always keep all of your money in GICs even within a brokerage account.

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What made you choose where you would keep your RRSP? Was it the physical location of the institution? Where you keep your chequing account? Fees? Please share your experiences with a comment.