Congratulations if you managed to make a contribution to your registered retirement savings plan (RRSP) before the February 29 deadline. Your reward? A lower 2023 income tax bill and the prospect of tax-free growth on your investments until retirement. However, if like many Canadians, you temporarily “parked” your contributions in cash, it's time to shift gears and incorporate it into a broader portfolio strategy.
While there's no deadline to invest your contribution, the sooner you put it to work, the better. Time is your ally here, allowing the power of compounding to work its magic over the years. Moreover, it presents an opportunity to reduce overall portfolio risk by diversifying across sectors, geographies, and asset classes. Seeking guidance from a qualified advisor can be beneficial, but there are also ways to save on fees and start on your own.
Diversification across sectors is crucial. The past year highlighted how various equity market sectors don't move in unison. For instance, technology stocks soared with a 56.4% gain, while utilities faced a 10.4% loss on the S&P 500. Predicting the top-performing sectors each year is risky, emphasizing the importance of holding a mix of major sectors like consumer discretionary, staples, energy, materials, healthcare, financials, and real estate.
Canadian investors often overweight their retirement portfolios with domestic equities, which make up less than three percent of global equities. To achieve geographic diversification, consider U.S.-listed equities, constituting about half of global equities. Overseas equities, accessible through mutual or exchange-traded funds, offer exposure to regions like Europe, China, Japan, and emerging markets in India and South America.
When it comes to investing, Canadians often opt for mutual funds due to their blend of diversification and professional management. However, high annual fees, often exceeding two percent, can significantly impact your returns over time. Passive alternatives like exchange-traded funds (ETFs) offer cost-effective diversification by tracking market-weighted indices. They can cover broad indices or specific sectors, allowing for the creation of a diversified portfolio entirely with ETFs.
While both mutual funds and ETFs have their pros and cons, as your portfolio grows, targeting winners directly by investing in individual stocks becomes an option without sacrificing diversity.
Beyond capital appreciation, generating and compounding income is essential for long-term investors. Many blue-chip equities, especially in Canadian financial, telecom, and real estate sectors, offer generous dividends. As you age, shifting a larger portion of your portfolio to income-generating investments, like government bonds and guaranteed investment certificates (GICs), becomes crucial for a reliable income source when needed. The recent uptick in interest rates has resulted in annual yields that often exceed five percent.
In conclusion, if you've parked your RRSP contributions, now is the time to take the wheel and drive them into a diversified, well-managed portfolio that can maximize your returns over the long term.
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