When you look at your RRSP statement each month, do you wince at the sight of one or two flyers you took; promising little investments that just didn't quite work out?
To steal a phrase from Bill Clinton, I share your pain. Past misadventures with the likes of Dylex Ltd. and Bramalea Inc. left potholes in my retirement savings that can never be filled, and are part of the reason I'm now a mutual fund buyer.
My pain grew more severe after reading this month's edition of the The Successful Investor newsletter, in which editor Patrick McKeough sets down the triple whammy that comes from losing the money sheltered in your registered retirement savings plan.
When you pick up $1,000 worth of Bramalea and watch it head south, never to return, the initial hit comes from the capital loss. That hurts.
The second hit comes at tax time -- over the years, successful investing can have as much to do with smart tax planning as it does with stock picking.
"Losses are worthless in an RRSP," explains Geena Katz, a tax partner with Ernst & Young. Because your holding is already sheltered in your RRSP, a loss can't be used to offset capital gains you (hopefully) made on other investments. What makes the loss of the tax benefit even harder to take is the latitude Revenue Canada allows investors in offsetting capital gains.
"No one ever wants to lose money, but if you do, Revenue Canada allows you to offset gains made in the past three years, or you can carry the loss forward indefinitely," Ms. Katz said.
Finally, by kissing your RRSP savings goodbye, you've said farewell to the wonderful benefit that comes with tax-free compounding over the life of your portfolio. Mr. McKeough noted after just seven years in an RRSP, compounding has added more to the value of your investment than the initial contribution.
"For many people, all their investments are tied up in an RRSP," Mr. McKeough said. "The basic rule to follow is to have a good mix of quality investments."
Now, no one approaches their investments with the intention of losing money. But given the high cost of poor picks, Mr. McKeough has set out a list of sectors that he would avoid when it comes to an RRSP. They include:
Speculative mutual funds, such as certain high-tech funds. Let's face it, if you're pouring money into funds that are chock-a-block with Internet stocks, you're flirting with the risk of substantial losses.
Emerging market mutual funds. In addition to the greater volatility and the attendant risk of higher losses, there are tax issues. "Some countries impose a withholding tax on investment income paid to foreigners," Mr. McKeough said. "You can get a Canadian tax credit for these taxes only if you hold the fund outside your RRSP."
Startup companies. The odds say most small companies never make it big. Given that a high percentage of these holdings are going to yield losses, they are better held outside an RRSP.
Labour-sponsored mutual funds. They typically invest in small, high-risk companies, and are therefore more likely to lose money than more conservative funds.
Penny mining stocks. History teaches that the vast majority of junior gold plays will never play out, and most oil exploration companies will come up dry. These speculative holdings don't belong in an RRSP.
Stock options and warrants. "They expose holders to the risk of total loss, and should never be in an RRSP," Mr. McKeough said.
"Gimmick investments" such as flow-through shares and certain royalty trusts. Again, these often represent a stake in resource companies that may amount to nothing. Given the choice, such investments are better placed in taxable portfolios.
Turnaround plays. The problem with grabbing a stock as it's heading downward is the strong likelihood it will keep heading downward.
What does belong in an RRSP? For starters, fixed-income investment such as bonds or guaranteed income certificates. An RRSP shelters the interest income that you earn. The same applies to any distributions that come from conservative mutual funds -- the tax bill for any distributions is deferred until you make withdrawals from your RRSP.