A Golden Rule of Investing in your RRSP

Global diversification is one of the “golden rules” when it comes to investing in your Registered Retirement Savings Plan (RSP). But like many Canadians, you may be wondering why it’s so important to diversify your RSP with global investments. After all, Canadian stocks have been a solid investment for many years, while other stock markets, most notably the U.S., have struggled.

 However, there are some good reasons for investing outside of Canada – and while it may come as a surprise, the recent strong performance of Canadian markets is one of them.  While the Canadian stock market still offers good value, many Canadian stocks now trade at large premiums to their global peers.  Valuations will tend to revert to the mean over time (those that are above average will trend down toward the average and those that are below average will trend up toward the average), which could weigh on the performance of some Canadian stocks in the years to come.

 Canada’s strong performance also means that your RSP may now hold a greater percentage of Canadian investments than it did a few years ago. For example, say you had diversified your RSP a few years ago with 70% Canadian investments and 30% global investments. But now, due to its relatively strong performance, the Canadian component of your RSP might account for 80% of your RSP’s market value, while the global component has dropped to only 20%.

 Why is this important? Because setting – and maintaining – the right balance of global and Canadian investments helps reduce risk. Diversifying globally helps reduce risk because stocks in different parts of the world do not always go up or down at the same time. When you have a globally diversified RSP, weaker performance in any single part of the world – including Canada – can be offset by stronger performance in another.

 Canada’s markets are also concentrated in just a few industrial sectors – namely, the Financial, Materials and Energy sectors. Just as you can diversify by geographic area, you can also diversify by industry sector to reduce risk. So when you forgo global stocks in your RSP, you not only forgo the risk-reduction benefits offered by global diversification – you also forgo the risk-reduction benefits offered by sector diversification.

 In addition to reducing risk, there are many other reasons to diversify your RSP globally, including:

 Greater opportunity

Canada only represents 3% of the investment opportunities available worldwide. That means the vast majority of investment opportunities are beyond Canada’s borders, in places like the U.S., Europe and Asia. And with Canadian markets strongly weighted in just a few sectors, you may not necessarily be able to find quality companies in certain sectors, if you want to diversify by sector to reduce risk. By going global, you can choose from a larger pool of quality investments in a wider range of sectors.

 Enhanced return potential

Several international markets have historically performed better than Canada. By taking advantage of the growth potential offered by global markets, you can enhance your RSP’s return potential. Increasing your RSP’s rate of return by even one or two percentage points can have a dramatic impact on yoru post retirement income.

 No more foreign content limit

Up until 2005, the foreign content rule limited RSP accounts to invest only 30% in global investments. With the elimination of the rule, you now have more flexibility in choosing the investments that can best help you achieve your retirement goals.

 Contact Michael Flus at (289) 969-5735 for more information about setting the right level of global diversification in your RSP.

 This article is supplied by Michael Flus, an Investment Advisor with RBC Dominion Securities Inc. Member CIPF.  Michael can also be reached via email at Michael.Flus@rbc.com