Understanding the Bank RRSP

If you haven't made your RSP contributions yet, there's still a few hours before the deadline, so make it count. When it comes to investing in your RSP, there are many vehicles that allow you to grow your money. Unfortunately for most individuals, their RSPs are at the banks and not at a brokerage, limiting their options to low yielding products. Banks can not tap the equity markets, except in the case of mutual funds, as a result, you'll be stuck "purchasing an RSP," a commonly misused term by banks. But what are you actually "buying" when your money is contributed into the RSP?

The most likely product available at the banks would have to be a Guaranteed Investment Certificate (GIC). They are covered up to $100,000 by the CDIC and are easily accessible at the banks, however, not all GICs are available. Most banks will promote their in-house GICs before their competitor's. Shopping around and researching the best GIC might be a benefit if we're talking about bigger numbers. Canoe has posted the GIC rates for Canadian institutions, available here.

Unfortunately, as you may have seen, the rates for short-term GICs are substantially low. A $10,000 investment in a GIC for one year is going to yield you at most 2.25%, which works out to $225 in a year. And the big banks don't offer anything close to 2.00%. Not something worth cheering about, but that is the trade off when you want to protect your principal.

With interest rates in Canada expected to rise in the next few years, it might be worth laddering your investment. Laddering is a strategy investors often used to evenly spread out their wealth amongst an investment product with different maturity dates. This prevents investors from investing all their money during unfavourable market conditions, as is the case today. If rates were to rise, GIC rates would reflect this and would go up. But if you put all your eggs into a five-year basket, your GIC would not go up with it because the rates are fixed. By having a cash flow that participates in future rate changes, it allows you to potentially capture future interest rate increases.

Another added benefit with laddering is anticipating liquidity. Locking all your funds from today's contribution for five-years might seem like a good idea today, but what if an emergency were to come up in three years? GICs can not be sold prior to the maturity date, unless ordered by the Supreme Court of Canada under financial hardship, and it is very rare for the courts to rule you so poor you must break a contract between you and a financial firm. Of course, deregistering your funds (withdrawing your money from an RSP), is a totally different story and should be a last resort.

It can also provide you with money for large purchases. The Canadian government created the First Home Buyers Program years ago, and tapping the funds from an RSP is common. By being able to predict and anticipate your funds to the penny for such programs is a valuable asset.

Lastly, determine when interest payments are made. Most GICs have interest paid out annually on the anniversary, however it is possible for some GICs to offer a monthly payout with a reduced interest rate. Do the math and see what nets you more over the long haul. Remember that interest in a GIC can be compounded and ensure your interest is re-invested back into the GIC, otherwise, it will sit as cash in your RSP earning next to nothing.

The banks make "buying an RSP" very simple, and in a nutshell, it is. But even with a low-yielding product such as a GIC, there are many strategies most investors have never considered, and there are more than those discussed here. You've worked hard for your money and you deserve to get as much out of it as possible. It might sound like being cheap, but you're gonna need the nickels and dimes when you're retired.