Balance risk against return

One concern worth discussing is the degree of risk within your registered accounts.  Registered Retirement Savings Plans are typically designed to fund your retirement.

It’s not a question of how to invest your hard-earned dollars, but more specifically, how much risk should you take within your RRSP account?

Tom and Linda Green both have RRSPs.  Tom, 46, is an engineer and Linda, 45, is a teacher.  They have been married for 11 years.  Tom is not interested in fixed income as he considers the rates too low.  Tom would like his RRSP to be 100 per cent equities.  Linda had a bad investing experience two years ago and prefers 100 per cent fixed income.

The following summarizes some of our discussion points we had with both Tom and Linda.

Household Investments:  The first question that we asked was whether or not they viewed their investments individually or as a household.  Both said household.   After that response we went on to explain how most of the portfolios we design have a balance of fixed income and equities.  The way the portfolios were currently structured, one portfolio would likely be outperforming the other in any given year.

Fixed Income:  We asked Tom why he objected to fixed income in his portfolio.  He responded by saying that a three per cent GIC doesn’t earn anything after taxes and inflation are factored in.  We explained to Tom that over the last year we were able to purchase fixed income for our clients with yields of up to ten per cent.  We discussed corporate bonds, debentures, and other fixed income options that provide a better return, with a little risk.  Tom was open to adding a fixed income component to his portfolio.  There are times in the market cycle when there are growth opportunities in the fixed income markets.

Equities:  We asked Linda why she was so cautious about equities.  She had invested in some technology stocks and sold all of her equities after a one-year period at a significant loss.  We explained to Linda that equities are typically classified as low, medium and high risk.  The stocks she had invested in were all “high beta” or “high risk.”   We also noted that she had some bad timing when she bought the investments initially.  We outlined a few low risk, high dividend paying stocks.  We also reviewed market cycles and the importance of focusing longer term when equity investing.  Linda was open to adding a few low risk equities to her portfolio.

 Time Horizon:  Tom and Linda both plan on working another 15 years each.  We talked about how the overall asset mix should become more conservative as they approach retirement.  We refer to the five-year period before retirement as the “risk zone.”   We discussed a disciplined approach and documented this through an Investment Policy Statement.  The statement covered their investments as a “household.”

Other Accounts:  The only accounts that Tom and Linda currently have are registered (both have an RRSP and TFSA).  Tom and Linda are nearly debt free.  They have been aggressively paying down their mortgage.  In about three years time they will be debt free and plan on directing excess cash to a joint with right of survivorship (JTWROS) non-registered investment account.  We explained that once they begin saving outside of registered accounts they should consider shifting the higher risk equities out of their RRSP into the JTWROS account.  We explained that losses within an RRSP are wasted.  A loss within a non-registered account may be carried back three years or forward indefinitely.

Return versus Risk

It was obvious in our initial conversation with Tom and Linda that they both viewed investing from different angles.  Tom looked at returns first, where Linda looked at risk first.  Together they compromised on a balanced portfolio with a moderate level of risk.