Next Monday is your deadline for making an RRSP contribution that will count towards your 2008 tax return.
I want to make an important clarification on how much one is able to contribute. If you look at your Notice of Assessment, which is the document that you are sent from CRA after you file your tax return, you will see your “RRSP deduction limit for 2008” listed as (A). You may also have an amount of “Unused RRSP contributions” listed as (B) available for 2008. This is the number one area of confusion for many people. Basically, the amount that you can contribute without going over is A-B. If you over-contribute, you will have a 1% per month penalty along with more confusing paperwork that will cost you and/or accounting fees to straighten it all out. It is best to see your financial advisor or tax accountant if you are unsure as to how much you can contribute.
A second question I’m hearing from my clients is whether or not to contribute at all this year. I believe this question stems from some of the concern around market volatility and economic uncertainty. However, the question of whether to contribute should be more of a tax strategy due to the fact that a contribution can be made into any investment, including cash, if one is concerned with investing in the market. An RRSP contribution doesn’t automatically mean you have to invest in equities, instead it should be viewed as a strategic tax decision. If it makes sense from a tax perspective to contribute, then that should be the primary decision. Secondary is what your contribution will be invested in, if anything at all. This decision should be an informed one, made following a discussion with a financial planner to review long term goals and your own customized circumstances. It has nothing to do with what your neighbor or friend is doing. That person will not be living your retirement.
Here are 4 tips to consider with respect to your RRSP:
RRSP Tip #1: Keep making regular contributions and increase them if you can.
The worst time to stop contributing to your RRSP is when the market is down. Think about it. When the price of gas falls, do you stop filling up your car? No. If anything, you fill up more often before prices go back up.
The same principle applies to your RRSP when you have time on your side, i.e. over 8 years. You want to keep adding to your investments (and buy more if you can) while they’re selling at a discount. Lower prices mean you can buy more shares with the same contribution. This lowers your average cost basis and sets you up for bigger returns when the market recovers.
RRSP Tip #2: Review your asset allocation.
The foundation of your retirement plan is your asset allocation strategy. This is the optimal mix of stocks, bonds, and cash for your portfolio. The right mix for you depends on your specific goals, time horizon, and tolerance for risk. Research shows more than 90% of your long-term investment returns are determined by your asset allocation.
Right now is a critical time to review your asset allocation. While your gut is saying sell out of stocks entirely, your asset allocation might say to buy more. Following a sound asset allocation strategy will bring discipline to your decision-making and better long-term returns. Make sure you are properly set up for an eventual recovery as well.
RRSP Tip #3: Diversify your investments
As the old saying goes, don’t put all your eggs in one basket. Spread your investments across several different investments. Diversify by size of company through large-cap, mid-cap, and small-cap stock funds. Get exposure to both growth and value investment styles. It doesn’t seem like diversification worked in 2008 given that almost every asset sank in value, however the strategy does work well over 5-10 year stretches because normal markets do produce winners and losers and nobody has that crystal ball to know when the winners will hit the mark.
RRSP Tip #4: Don’t panic and sell your investments to cash just because the market is down.
I know it’s scary to see huge losses on your account, but selling out when the market is down is a catastrophic mistake. Right now those losses are on paper. If you sell and sit in cash, you lock those losses in forever. If retirement is still years or decades away, you have plenty of time for your portfolio to recover.
The past year has truly tested investors and there are days where you may feel it is time to throw in the towel. Many investors have saved diligently for years and now they’re looking at account balances down by 40% or more. Everyone has been impacted by this…myself included. But this is a critical time to be working with an advisor you trust; someone who will put your interests ahead of their own, and provide guidance and direction during these times. And the right direction can only be dictated by your goals, dreams, and financial plan. If you don’t have a plan, make it your 2009 priority to get one!