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"Mutual funds work well because you're not putting all your eggs in one basket." | |
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What's an RRSP? Registered Retirement Savings Plan. Any bank can set you up with an RRSP. Think of an RRSP as a box. You can put virtually anything in the box. I'm talking good 'ole cash, mutual funds, stocks, options, etc. The RRSP is simply a holding area for assets. The beauty of the RRSP is that it is protected from the government as long as the money stays within it. You cannot be taxed on holdings within your RRSP (until you remove the money from the 'box'). Jessie James posted a concern on RRSP's, but didn't really elaborate. An RRSP by itself is not a dangerous thing. It's just a box. What you decide to put into the box determines your risk. RRSPs are one of the last tax shelters we as Canadians have. I'm going to put this bluntly folks: You're crazy not to take advantage of it. Furthermore, anything you put in an RRSP is deducted from your gross income. Here's why this is important: Throughout the year, you pay provincial and federal income taxes. The amount of tax you pay, of course, depends upon the amount of money you make. By putting some money into your RRSP, that money is protected from taxes. That amount comes directly off your gross income. Example: If you made $25,000/year, and you put 10% away into an RRSP ($2,500), then you're taxable salary has been reduced to $22,500. Considering you were paying taxes throughout the year at a salary of $25,000, you are now entitled to an income tax refund. While this will seem like a windfall, the best thing to do is to take that windfall and put it into your RRSP. You just gained more on your savings (on top of the 10% you're still putting in every pay!) Cash sitting inside an RRSP is no better than cash sitting in a bank account. You're not making anything off of it. The key, if you remember, is compound interest. Interest on top of interest. Most people do not have the interest, time, desire, etc. to put into investing. Quite simply, it's boring to them. Who knows how to pick stocks? Look at the big Nortel crash 5-6 years ago...people lost a lot of money. While I didn't lose big, I do have some Nortel holdings and did take a minor hit. Stocks are risky. Stocks require constant monitoring, analyzing finanacial reports, and watching the market. It's not an easy task. So what's a budding investor to do? Enter the mutual fund. Mutual funds are diversified investments. Rather than buying one stock, you're buying little bits and pieces of a LOT of stocks. The mutual fund is managed by a fund manager. They do all the tough work. They track the markets. They watch the trends. They actively juggle the mutual fund, buying and selling stocks as required, and make the fund grow. Mutual funds work well because you're not putting all your eggs in one basket. If one stock within your mutual fund goes down, another may go up. Because you're buying shares every single month, you have little concern on the current market price. You're in it for the long haul. Some months, you'll pay more than the previous month for your shares - other times, you'll pay less. Lets take an example of a diverisifed fund that contains stocks of several companies. In January, you bought $100 worth. At the time, the market price was $10 per share, so you end up with 10 shares. In February, you bought $100 worth, but the fund had lost money a bit. It was at $8 a share. You just bought 12.5 shares (for a total of 22.5). In March, you bought $100 worth, but the fund was up to $11 (those shares you bought last month at $8 each just made you $3 apiece!). You only get 9.09 shares this month (for a total of 31.59). Cost averaging the shares (using the $300 total you've invested divided by the number of shares you own) $300/31.59 each share only actually cost $9.49. I hope you're still with me. Next topic, I'll cover things to watch for when purchasing mutual funds - they're not all created equal! I'll also discuss the importance of diversification. If you have any questions on all this, please feel free to leave a comment. |
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