What’s your RRIF risk quo­tient?

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IRECENTLY RE­CEIVED an email from a reader who asked a ques­tion that seems to con­found a lot of us. “I have to con­vert my RRSP to a RRIF by the end of this year,” she wrote. “What are the best in­vest­ments to put into my new plan?”

I get this type of ques­tion a lot. Un­for­tu­nately, it’s the wrong one to ask. Choos­ing the best in­vest­ments should be the last stage in the RRIF con­ver­sion process. Mak­ing it the first pri­or­ity is putting the cart be­fore the horse.

But be­fore I get to that, some back­ground. Ac­cord­ing to the lat­est cen­sus, al­most two-thirds of Cana­di­ans are ac­tively sav­ing for re­tire­ment in ways other than the Canada Pen­sion Plan. Among older peo­ple, Reg­is­tered Re­tire­ment Sav­ings Plans (RRSPs) are the pre­ferred op­tion; younger peo­ple pre­fer TaxFree Sav­ings Ac­counts (TFSAs).

A TFSA is for life; it never needs to be spent or con­verted. RRSPs are dif­fer­ent. Un­der cur­rent law (one which should be re­viewed, in my opin­ion) you must cash in your RRSP by Dec. 31 of the year in which you turn 71. You have three op­tions:

1 With­draw all the cash and be taxed at a usu­ri­ous rate on it. 2 Pur­chase a life an­nu­ity. 3 Con­vert to a Reg­is­tered Re­tire­ment In­come Fund (RRIF). This is what most peo­ple do, hence the ques­tion about the best in­vest­ments for such a plan.

RRIFs dif­fer from RRSPs in two ways: you can­not make any fur­ther con­tri­bu­tions once you have con­verted and you are re­quired by law to with­draw, and pay taxes on, a min­i­mum amount each year. What it boils down to is that a RRIF is not a sav­ings plan. It’s an in­come plan.

So the first ques­tion you should be ask­ing is not what to in­vest in. It should be how much risk are you will­ing to take with your re­tire­ment sav­ings? By the time you’re in your 70s, you don’t want to be hit with an eco­nomic calamity that en­dan­gers your stan­dard of liv­ing.

That’s ex­actly what hap­pened when the stock mar­ket crashed in the fall of 2008. Be­fore the car­nage ended in March 2009, the S&P/TSX Com­pos­ite In­dex had lost about half its value. The drop in New York was even worse. It can hap­pen again.

With that in mind, your first pri­or­ity in con­vert­ing to a RRIF should be pro­tect­ing your cap­i­tal. That re­quires a U-turn in your think­ing. Dur­ing the RRSP years, growth at a rea­son­able risk should be the No. 1 goal. Now the fo­cus is on gen­er­at­ing in­come from your in­vest­ments in the safest pos­si­ble way.

That starts with as­set al­lo­ca­tion. How much money are you go­ing to com­mit to equities, fixed in­come and cash in your RRIF? Never lose sight of the re­al­ity that any money in­vested in the stock mar­ket is at risk, no mat­ter how safe the se­cu­rity may seem. When the mar­kets went over the wa­ter­fall in 2008, it wasn’t only the high-risk stocks that got swamped. Banks, util­i­ties, telecom­mu­ni­ca­tions com­pa­nies and real es­tate in­vest­ment trusts – all usu­ally con­sid­ered to be low-risk – were swept away as well.

With in­ter­est rates still very low (but ris­ing), the temp­ta­tion is to over­weight a RRIF to div­i­dend­pay­ing stocks. That may pay off in the short term, but it’s a risky ap­proach. My sug­ges­tion is to start by cal­cu­lat­ing how much cash you’ll be re­quired to with­draw in the first

two years and put that into a high­in­ter­est sav­ings ac­count. That way you won’t be forced to raise money by sell­ing in a fall­ing mar­ket.

As­sum­ing you’re start­ing at age 71, that would mean hold­ing a lit­tle more than 10 per cent of the plan’s value in cash. For the rest, I sug­gest putting 60 per cent into fixed in­come and 30 per cent into stocks or the funds that in­vest in them.

I rec­om­mend a large fixed-in­come al­lo­ca­tion even though ris­ing in­ter­est rates are hurt­ing bond prices, and you may suf­fer some small losses in the short run. But be­lieve me, a tem­po­rary de­cline in the bond mar­ket will be nowhere near as dam­ag­ing to your sav­ings as a stock mar­ket crash.

Now we can ad­dress the ques­tion of the best in­vest­ments. Ideally, you should be deal­ing with a qual­i­fied fi­nan­cial ad­viser who is knowl­edge­able about RRIFs. Here are two sug­ges­tions you can ask about.

On the fixed-in­come side, con­sider the PIMCO Monthly In­come Fund or its equiv­a­lent ex­change­traded fund (TSX: PMIF). It in­vests in­ter­na­tion­ally, and the Cal­i­for­ni­abased man­age­ment firm is con­sid­ered to be one of the top fixed­in­come spe­cial­ists in the world.

The ETF is new, but the re­turns from the mu­tual fund’s F units, which have the same man­age­ment fee, have done well. The mu­tual fund’s F units gained 4.24 per cent in the year to April 30. The three-year av­er­age an­nual com­pounded rate of re­turn was 5.04 per cent, and the five-year fig­ure was 5.56 per cent. Distri­bu­tions are paid monthly.

The equity side of the equa­tion is more prob­lem­atic. As I said, there is no such thing as a to­tally safe stock in­vest­ment. A fall­ing tide low­ers all boats. What you are look­ing for are se­cu­ri­ties that have a record of su­pe­rior per­for­mance in down mar­kets and that gen­er­ate good cash flow.

The best so­lu­tion in this case is a

bal­anced fund – one that in­vests in a com­bi­na­tion of stocks and bonds. When stock mar­kets are strong, they will un­der­per­form. But when they tank, your loss will be limited.

The CIBC Monthly In­come Fund is a good ex­am­ple. In the Great Re­ces­sion, when the TSX lost half its value, this fund dropped only 17.36 per cent over the year to Feb. 28, 2009. That was the worst 12-month per­for­mance in its his­tory. The fund pays monthly distri­bu­tions of $0.06 a unit ($0.72 a year) to yield al­most six per cent as of the time of writ­ing (A units). So it scores on both counts – limited down­side risk and steady in­come.

In cal­cu­lat­ing your over­all as­set al­lo­ca­tion, in­clude the fund’s bond hold­ings in your fixed-in­come cal­cu­la­tion and the stocks with your equities.

Of course, you will need to own more than two se­cu­ri­ties in your RRIF. But th­ese will give you a start­ing point when the time comes to make the switch.

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