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The Truth About RRSPs

RRSP season is nearly over and you’ve probably seen ads from all the major financial institutions encouraging you to make a contribution. But what they may not be publicly tell you are the RRSP truths.

I’m not suggesting that they’re saying anything misleading, but facts aren’t sexy to talk about, and it’s so much easier to convince people that they’re richer than they think.

How you save for your retirement has changed in the last few years. TFSAs have been introduced, but most Canadians still use their RRSP to fund their golden years. Simply making regular contributions to your RRSP is a good start, but you need to make sure how you invest your money (whether it be in mutual funds, exchange-traded funds, GICs, or a high-interest savings account) fits your individual situation.

You need to save more

Employer pensions are becoming increasingly rare and it’s foolish to expect any government payments to fully fund your retirement so that means you need to start saving more. With consumer debt rising, some Canadians have delayed saving for the future and that’s a huge mistake.

Saving as soon as you can, even if it’s just a small amount works wonders due to the power of compound interest, but you need to give it time to work its magic. Try not to fall into the “I’ll save later” trap. Saving later means you’ll need to save a lot more and even then you won’t necessarily catch up, since your money hasn’t been compounding.

Don’t spend your tax refund

Spending your tax refund is a huge mistake. It’s not free money or found money, it’s simply the tax-deferred portion of your RRSP contribution which you have to pay back eventually. That’s right, you pay taxes when you withdraw money from your RRSP. The assumption is that you’ll be in a lower bracket when you retire so that’s why you want to defer those payments.

Reinvesting your refund may not sound fun, but it’s one sure way to increase the size of your RRSP. Since you’re adding that amount to what you’ve already invested, you’re really taking advantage of the power of compounding—your refund will grow every year.

Buy low, sell high

Last year was quite the year for stocks. The Canadian economy did poorly and the S&P/TSX Composite Index saw double-digit losses while most international markets were flat or posted gains. Many investors tend to panic when markets drop so they sell their losers to buy the winners. This is the worst strategy possible. You’re basically selling low and buying high; smart investors do the opposite.

By selling high and buying low you’re essentially locking in your gains. This goes against human emotions, but think about it this way: when the markets are doing poorly, consider it a buying opportunity since stocks are technically on sale.

Borrowing to invest isn’t for everyone

Interest rates are low so borrowing money for an RRSP contribution might make sense, but it’s not for everyone. In theory you’ll use your refund to pay back a portion of the loan, but it could take a long time before your debt’s been cleared, especially if you get an RRSP catch-up loan.

Leveraging is great when your investments are going up in value, but how would you feel if all of a sudden that borrowed money devalued due to a decline in the market? TV commercials make it seem like borrowing to invest is a no-brainer, but for most investors it’s probably better just to save more.

Flickr: KMR Photography