Pat yourself on the back if you managed to make a contribution to your registered retirement savings plan (RRSP) before the February 29 deadline.
Your reward starts with a lower 2023 income tax bill and continues with tax-free growth on the investments inside until they are withdrawn in retirement.
If you’re one of the millions of Canadians who scrambled to meet the deadline and temporarily “parked” their contributions in cash, the time has come to put it in drive as part of a broader portfolio strategy.
There is no deadline to invest your contribution but it’s important to put it to work as soon as possible to seize the power of compounding over time.
Time also brings the opportunity to lower overall portfolio risk by diversifying investments according to sector, geography and asset classes. This is where a qualified and experienced advisor can help, but there are ways to save on fees and get started on your own.
Investing across sector lines
2023 was a typical example of how the various sectors of the equity market do not move in tandem. Technology stocks, for example, were the best performers on the benchmark S&P 500 with a 56.4 per cent gain, and utilities were the worst performers with a 10.4 per cent loss.
The relative performance of those two sectors, and all others, varied wildly in previous years and will likely vary wildly in the future. That’s why it’s important for long-term investors to hold a mix of each major sector including consumer discretionary, consumer staples, energy, materials, health care, financials and real estate.
Targeting which sectors will perform best in any particular year is risky. Diversification will bring returns more in line with the broader market over time.
Creating a global portfolio
Canadian investors are notorious for over-weighting their retirement portfolios with Canadian equities, which account for less than three per cent of publicly traded global equities. Even within that tiny sliver, two-thirds of the stocks listed in Canada are finance or natural resource-related; tying a few individual stocks too closely with portfolio performance.
Canadians have the advantage of achieving geographic diversification through U.S.-listed equities, which account for about half of global equities.
It is also possible to invest in overseas equities through mutual or exchange traded funds. Like sectors, performance varies among geographic regions over time. Some of the key areas for investment include Europe, China, Japan and emerging markets such as India and South America.
Active or passive
Most Canadians invest for retirement through mutual funds because they are the only way for average investors to access a combination of diversification and professional (active) management.
However, annual fees often top two per cent of the total amount invested, which can seriously eat into the amount invested and compounded over time.
One alternative that can provide diversification for a fraction of the cost is passively managed exchange-traded funds (ETFs) that automatically track market-weighted indices such as the S&P 500, India’s Sensex or China’s Hang Seng.
ETFs are also available for specific sectors, which allows the opportunity to create a diversified portfolio entirely with ETFs.
On the downside, you have to take the winners with the losers with mutual funds and ETFs. As a portfolio grows, it is possible to target the winners directly without sacrificing diversity by investing directly in individual stocks.
Income and stability
While it’s important to choose equities that go up in value, investing for the long term also brings an opportunity to put your portfolio in overdrive by generating and compounding income.
Many blue-chip equities, including Canadian financial, telecom and real estate investments, pay generous dividends.
Creating an income stream and devoting a greater portion of a portfolio to income-generating investments becomes more important as an investor gets older and requires a more reliable source of income when they need it.
The most reliable source of income is fixed income such as government bonds and guaranteed investment certificates (GICs). The recent spike in interest rates has resulted in annual yields that often top five per cent.