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Unravelling the RRSP Wrapper

Many Canadians see products labelled as “RRSP savings accounts” and believe that putting their contributions into one of these offerings means they now have a retirement fund that will grow for years to come.

This is a mistake, though. An RRSP savings account is simply a tax-sheltered savings account. It is not, by itself, an investment capable of producing capital gains (or significant income, given the paltry interest often paid by these accounts).

RRSP savings accounts can be useful for short periods of time, particularly if you need to think about where you want to invest your contribution. But they are not beneficial in the long-term.

Once you’ve made the contribution, you need to give some thought as to what investments you wish to hold within the account. So with that in mind, let’s take a look at the choices available to an investor, and the pros and cons of the various options.

Guaranteed investment certificates

Guaranteed investment certificates (GICs) are essentially loans to a financial institution. In exchange for the use of your money, a bank will pay you an advertised rate of interest for a set term. GICs can be purchased for terms as short as 30 days and as long as 10 years (1 to 5 years are the most common). Depending on the particular GIC, it may be either cashable or non-redeemable. If you think you might need access to your money before the term is up, a cashable GIC is probably a better move.

Pros: GICs are generally considered conservative investments, and they do pay some interest. GICs with terms of 5 years or less are also backed by deposit insurance.

Cons: The interest can be minimal (but more than a regular savings account), and any significant bout of consumer price inflation could eat into your purchasing power.

Mutual funds

Mutual funds are professionally managed portfolios where your money is pooled with other investors’ money and invested in a basket of securities (typically stocks and bonds). Most mutual funds offer Canadians exposure to the performance of the stock market. Among mutual funds, there are offerings that invest in the entire market, as well as those that focus on a particular sector (such as energy or precious metals).

Pros: Most people are not professional investors, so a mutual fund does allow a certain piece of mind as you know someone else is managing your money. If the stock market goes up, the odds are good a broad-based mutual fund will as well.

Cons: Fees on mutual funds can seriously reduce your returns. Many funds in Canada charge 2.0-2.5% per year. Over time, this represents a significant opportunity cost for investors, particularly because many funds that are “actively managed” (i.e. constantly buying and selling stocks at the discretion of the manager) both mimic the overall market and also tend to underperform it.

Index funds

Index funds have become very popular in recent years. These funds do not try to pick and choose which stocks will be the outperformers in the stock market. Rather, they will own all of the market’s stocks (or at least the ones in the main index). As a result, when you buy an index fund, you are essentially buying a fund that tracks the performance of the underlying market. Generally speaking, this provides diversification to your portfolio because you aren’t just buying one stock.

Keep in mind, however, that some stock markets are very concentrated in a few sectors. The TSX, for instance, is heavily weighted towards banks and resource companies. This presents a problem if these areas of the market go down.

Pros: Over the long-term, the stock market does tend to go up. And with an index fund, you are getting a very low-cost way to invest in the market. Whereas mutual funds can charge you 2.0-2.50% per year, many index funds only cost 0.30-0.50%; this will save you a lot of money over the years.

Cons: Markets may generally go up over the long haul, but that does not mean they are a sure bet. Many market watchers are very concerned these days that stock markets around the world are overvalued. Should they decline significantly, the value of an index fund will also go down. This risk applies to mutual funds, as well.


Investors may also purchase bonds within an RRSP. These can be government savings bonds, publicly traded government bonds or even corporate bonds.

Pros: Bonds are legal liabilities of the issuer, and for corporations, the bondholders must be paid before shareholders receive dividends; this provides some protection for a bondholder. There’s also the advantage of receiving interest payments, although this is a very reduced benefit these days with interest rates so low. There is, in theory, the potential for capital gains on traded bonds if interest rates decline from today’s very low levels.

Cons: There are two risks to bondholders, both of which should be kept in mind in the current environment. First, there is always the risk of default, particularly if the bond issuer is in shaky financial shape. Second, any inflation will wreak havoc with the value of your money, because you will be paid back the money you invested, which will have reduced purchasing power.


Finally, Canadians may purchase gold for their RRSPs in a few ways. As long as they are bought from a qualified institution, gold coins or bars may be placed in an RRSP. Investors can also get exposure to gold from either a fund that is backed by physical gold, such as Central Gold Trust, or a mutual fund that invests in shares of precious metal mining companies.

Pros: Gold can act as a portfolio hedge. In some cases, the price of gold and gold stocks may move inversely to the stock market. So it’s possible that if the stock market falls, gold may rise. In addition, gold can protect you against unanticipated bursts of inflation. Owning gold is thus an insurance policy against your other investments.

Cons: Gold does not pay any interest, unlike a stock or bond (granted, that’s not why you would own it anyway). And the stocks of gold companies can often be very volatile.

The bottom line 

No matter which investments you choose to purchase in your RRSP, remember that the basic RRSP savings account offered by your bank is NOT one of them. Those accounts pay extremely low interest rates and are only meant for you to park your money now while you decide what to invest in. This is one instance where you would not want to “set it and forget it”. If the money is in savings, do your research and pick the best investment option for you.

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