Q: My husband needs to set up a RRIF within the next three months.
We currently have his RRSP in mutual funds with a bank with poor returns and fees of 2%+. We also have DB pensions and he is still working a few days a week for a while yet.
We are tempted to use a robo-advisor but wonder whether that is a safe strategy. His RRSP fund is about $210,000. Never used the robo idea before…. very tempting….but is it wise?
A: Robo-advisors have been aggressively targeting younger investors. I’m just a simple financial planner, so don’t know much about marketing, but I’m not sure why the focus has been so, well, focused. I feel like that marketing approach could scare off potential investors like you and your husband, Gladys. It shouldn’t – at least not necessarily.
Your husband must be 71, or at least turning 71 before the end of the year, seeing as how he must convert his RRSP to a Registered Retirement Income Fund (RRIF) before year-end. As you likely know, he needs to do something with his RRSP before year-end and the two primary choices are a RRIF or an annuity. Annuities could be a great option for a lot of people in the coming years, but I don’t want to go off on a tangent. That’s a topic for another article.
A RRIF is just like an RRSP in that you can own the same investments. In fact, when you convert your RRSP to a RRIF, your investments get shifted over from one account to another and you get a new account number. The primary difference between a RRIF and an RRSP is the mandatory withdrawals that begin in the year after you set it up.
In 2018, when your husband turns 72, his minimum withdrawal will be 5.28% of the account balance on December 31, 2017. The withdrawal rate rises each year, hitting 6.82% the year he turns 80 and 11.92% by the time he’s 90. This means he will probably be dipping into the capital of the account, causing the value to decline over time.
It’s worth mentioning, Gladys, that if you are younger than your husband, he can base his RRIF minimum withdrawal on your age. I think this is a good idea for anyone with a younger spouse, because you can always take a larger withdrawal if you want. It sounds like you and your husband don’t need the RRIF income if you have DB pensions and he’s still working and you haven’t had to take withdrawals to this point.
The withdrawals are an important consideration when you set up a RRIF. You have to plan on how to fund the minimum required withdrawals, whether it’s with existing cash, selling investments over time, GIC or bond maturities, etc. It will impact your investment strategy. It may also impact your investment fees if you have to pay commissions or if you have deferred sales charges on your mutual funds (and if you do, that’s a red flag for the advisor who sold you those investments).
In defence of the bank, your poor returns as of late may just be because the markets have faltered. Canadian markets are down slightly year-to-date and the TSX is at the same level as it was about three years ago. So if you’re in primarily Canadian equities and paying 2%+ in fees, your capital has probably gone sideways and your 2%+ dividends have just covered the fees in recent years.
Conservative investments with a high exposure to bonds are also barely generating enough return to cover 2%+ mutual fund fees. This is a headwind for bond mutual funds and even balanced mutual funds with 30-50% in low-yielding bonds.
So fixed income and Canadian stocks have provided weak returns in recent years, but with 2%+ in mutual fund fees, any investor is going to have a hard time generating good relative returns compared to a benchmark, Gladys. Bank mutual funds are also notorious for playing it “safe” and investing very much like the indexes they track, so if you invest like the index and pay 2%+ fees you will no doubt lag the index by 2%+ over the long run.
Robo-advisors are not safe. Nor are they risky. A robo-advisor is simply a type of investment company. Like mutual fund companies. And sometimes people irrationally think mutual funds are either safe or risky as well. They are. And they are not.
When you’re in a mutual fund, you can buy a short-term bond mutual fund that invests in very short-term government bonds. Very safe with low returns. Or you can buy a small cap technology stock fund that invests in small, volatile growth stocks. Risky with high return potential. So a mutual fund is just a way to invest in stuff. It’s the type of mutual fund that determines the resulting risk level.
Robo-advisors are the same. When you invest with them, you complete a risk tolerance questionnaire online which you then discuss with a real-life portfolio manager. Based on the risk assessment and the discussion, you have a pre-determined level of risk that is used to choose the balance between stocks and bonds. If you’re a risk adverse investor, you’re going to get a low-risk portfolio with a robo-advisor with more bonds. A healthy risk appetite will translate into a higher risk portfolio with more stocks.
The idea with a robo-advisor is to match up your risk tolerance to a personalized portfolio, Gladys. That’s actually the idea with any investment advisor, but I find the robo-advisors (and other portfolio managers) tend do it more scientifically than a lot of investment advisors.
If you’re concerned about the risk of a robo-advisor running off with your money or going bankrupt, that’s not much of a risk at all. The robo-advisors I know of open your account with a third party custodian like National Bank Financial. That’s where your money is – not with the robo-advisor. The robo-advisor just has the authority to tell National Bank which investments to buy, hold and sell in your account and the parameters are pretty rigid. So the robo-advisor isn’t going to make a judgement call and put everything into Japanese stocks or bet big on a biotech company or anything like that. They typically have a stable of 7-10 broad-based exchange-traded funds (ETFs) and your stock-bond mix may only be allowed to drift up or down very little from the pre-determined, agreed-upon target.
Hopefully that helps, Gladys. A robo-advisor may or may not be right for you and your husband. If you’re looking for a low-maintenance, low-cost portfolio with little correspondence and light customer service, it may work. If you want to sit down and have quarterly meetings, get financial, tax and estate planning advice or be very involved in the investment process, look elsewhere, but expect to pay higher fees.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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