Tuesday, 16 February 2010

Comparing Alternatives for Where to Invest RRSP or TFSA Contributions

Making a contribution to an RRSP or to a TFSA is not the end of the story. That's the saving step. The cash must then earn a return. What are some options and current returns amongst the different possible types of investments (see previous post Investment Building Blocks - Securities for more explanation)?

Inflation surreptitiously eats away at the value of your savings whether or not it is in a tax-deferred RRSP or TFSA. You cannot avoid it. Inflation has been at the lower end of the government's target range of 1 to 3%, coming in at 1.3% in 2009, but the average for the last 15 years or so has been the middle of the range at around 1.9%. It is Bank of Canada policy that inflation be 2%. If your annual return is anything below inflation, you are losing money in real terms, perhaps slowly, but nevertheless surely.

Leaving the money sitting as cash these days gets interest of 1% or so from major banks, even in a savings account (see rates on CANNEX).

CANNEX also provides a complete table of rates on offer in registered plans. Rates again are quite low. For locked-in GICs, you can get:
  • 1-year: 0.4% from major banks, higher rates up to 2.1% from smaller institutions
  • 5-year: 2% from the majors, maxing out at 3.6% from others
Returns on bonds include the interest and possible changes in capital value due to changes in default risk and interest rate risk. The longer the maturity, the greater the risk of interest rate increases. The examples below are investment grade bonds. Lower rated bonds will give off greater yields (see previous post Seeking Safety: Assessing Default Risk). An interesting choice is real return bonds of the Canadian government - the low yield is after inflation, in other words, the bond interest and capital is automatically adjusted upwards in line with increases in CPI, so the yield is protected from the ravages of inflation. A quick way to see a good sampling of current bonds and their yields is to go to this page on CanadianFixedIncome.ca.

Sample Yields as of February 2nd

Canadian Government
  • 2-year: 1.18%
  • 5-year: 2.46%
  • 10-year: 3.38%
  • 20-year: 4.02%
  • 17-year Real Return: 1.44%
Provincial Government
  • 4-year Ontario: 2.52%
  • 8-year Quebec: 3.64%
  • 10-year BC: 3.93%
  • 5-year Royal Bank: 2.88%
  • 19-year Bell Canada: 6.22%
Bond ETFs (contain various mixes of maturities and issuers)

For all types of bonds, get an exact price and yield online through the fixed income section of the brokerage website (the price you pay will be slightly higher and the yield will be slightly less than the CanadianFixed Income figure because the brokerage makes its revenue from the difference since there is no explicit trading commission charged). For less known or popular ones like real return bonds, it may be necessary to phone and speak to representatives at the fixed income desk.

Preferred Shares
There are many individual issues with varying returns, but the dividend yield of the following give an idea of the much more attractive returns available amongst preferreds. See Prefblog for much in-depth knowledgeable discussion of particular issues.
Income Trusts
Many of the business trusts are being converted to straight corporations or being bought out but many others still remain and their distribution yield remains high (see 2009 post Income Trusts: a Neglected Opportunity?).
Though much or most of the return from equities should come from capital gains, the straight dividend yield of equities, as expressed in the general averages for major markets like Canada's TSX index and the USA's Total Market or S&P 500 remains reasonable. The chance of market declines is the ever-present risk, which investors know all too well.
The above options are meant as a starting point. They only compare current cash payouts and not the change in value of the investment, which can drastically alter the net investment results both downwards or upwards. Leave it in cash or GICS, there's no risk, just the certainty of slow losses to inflation. As the saying goes, no risk, no reward.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

No comments: