If you wanted to take a six week trip across Europe, would you: A. Spend weeks on the internet, tracking down the most out-of-control Bierhalle in Germany, the best spot in Provence to stop for Pâté de Campagne, and the club in Budapest to catch Hungary’s sweatiest punk bands? B. Or are you the type, who two weeks before your trip would stop by the travel agency at lunch, toss your AMEX on the counter and hope for the best? If you’re the former, an independent, choose-your-own adventurer, you’re probably also the type who would choose a self-directed Registered Retirement Savings Plan over a basic RRSP.
Self-Directed RRSP Explained
First things first. RRSPs are not themselves investments, they are rather a type of tax-advantaged account that contains investments. So if you pipe up at your investor's club meeting and say you want to invest in an RRSP, you might sound like you have no idea what you're talking about.
A self-directed RRSP is a type of RRSP that can hold a number of different investment types under one roof. While regular RRSPs limit you to holding one type of investment such as mutual funds, this is not the case with self-directed RRSPs. So what goes into a self-directed RRSP? It depends. If it was a basic self-directed RRSP you were looking for, you could stop by most any bank branch and ask them for their finest RRSP, you’d be brought into the offices in back, a banker would ask you a few questions about your goals and risk tolerance and set you up with an RRSP containing a mélange of investments the bank recommended for people like you. Perhaps some of your money would be put in a GIC, some more of it in mutual funds, but most likely all the products in your new RRSP would be the banks’ own branded, internally managed products — proprietary investments they’re called. And apart from adding money to it regularly, your work would be done, and you’d hope that come retirement time, the bank would have done you right and the basic self-directed RRSP you started long ago would have turned into a nice big pile of money to last you the rest of your non-working days.
Those who desire control over the contents of their RRSP would never do any such thing. They’d likely open an RRSP at an online or brick and mortar brokerage or investment advisory. They'd also probably open a self-directed RRSP which would allow them to allocate their funds in whatever so-called RRSP “qualified” investment their hearts desired, anything from American stocks, to bonds, to real estate. The owner of the self-directed RRSP (or their investment provider) might spend more time managing their RRSP than the holder of the basic RRSP — but then again, they might not! (Don’t get too confused, but contrary to its name, just because an RRSP is called “self-directed,” you may enlist the services of an investment provider to help you manage your self-directed RRSP.)
Pros & Cons of Self Directed RRSP
Choice: As we outlined above, your choices of what to put into a self-directed RRSP are virtually limitless, which is a huge pro if you’re looking for investment variety. But this liberty could be considered a con if you’re reluctant to spend time picking investments and rebalancing your RRSP occasionally.
Fees: Depending on how you choose to fill it, the fees of a self-directed RRSP could be either significantly lower than those of basic RRSPs — or not. Both basic and self-directed RRSPs will assess an annual trustee fee just for holding your money, and brokerages will likely assess fees for trades in self-directed RRSPs, but what will probably make the biggest difference with your bottom line are the management fees (MERs) of whatever’s contained in your RRSP.
As the number crunchers have shown over and over again, fees are predictive of returns; the higher the fees, the lower the returns. MERs for Canadian mutual funds are among the highest in the developed world; the average Canadian mutual fund carries a management expense ratio (MER) of about 2%, meaning that every year, regardless of how well the fund performs, 2% of the entire fund will be deducted to pay fund salaries and expenses. One Toronto-based investment advisor showed that a fee of just 2% could decrease investment gains by half over the course of 25 years. If you’ve got a financial advisor minding your RRSP, you can count on another 1% or so shaved off your investment annually.
On the other hand, if you imagine that fees are termites and you the most gifted exterminator to ever squirt poison, you might decide to fill your self-directed RRSP with a diversified mix of very low-fee passive ETFs that simply track the stock and bond markets, rather than actively trying to beat it as mutual funds do. After all, studies show that almost all actively managed funds will fail to outperform the overall market over the long term. Automated investing services may help fill up your RRSP with a nice mix of low fee ETFs without charging an arm and a leg. Interested in lowering your fees? Maybe take a gander over here at this concise crash course on investing.
What’s A Self Directed RRSP Mortgage
If you can believe such a thing to be possible, in the event you decide to become a home or property owner you can become not only the mortgage borrower but the mortgage lender as well. How? By locating a mortgage in your RRSP. Something that's only possible if your financial institution is a registered bank (regretfully that means you can't currently have a self-directed RRSP mortgage with Wealthsimple).
Setting up a self-directed RRSP mortgage is a bit of a complicated manoeuvre. You might call it the Triple Lindy of mortgage financing, so chances are you’ll need the help of a professional, but indeed, rather than paying interest to a bank, you can pay yourself interest, providing yourself with a nice little fix-income return every month on any residential or commercial property you own in Canada.
As a lender, you won’t be able to approve a bigger mortgage than a bank would dare give you; to get the scheme approved, you’ll be required to go through an independent application process just as rigorous as any bank mortgage would require and if you fail to pay yourself back, just like the big bad bank, the trustee of the mortgage could foreclose on your home.
There are no interest rate bargains with RRSP mortgages; you’ll be paying so-called “posted rate” rather than the discounted rate that banks offer borrowers. But since you’ll be paying yourself the interest, cool, right? Well, there are some very smart naysayers out there who point out that a 5% rate of return, plus all the fees associated with setting one up make RRSP mortgages less appealing than just using that capital to invest in the stock market.
