There are a couple of topics tat readers raised in recent e-mails, and both affect Registered Retirement Savings Plans. Given that we will soon be into the full RRSP campaign, what better time than to address the issues. 

In reference to a previous article on global investing, Mr. G.B. writes; “Investors are encouraged to diversify by going global but in reality [going global] is expensive. Mutual Funds charge very high MER’s (management expense fees) on global funds. ETF's (Exchange Traded Funds) with low MER’s are an obvious solution but even with that there are problems.”

I will get to the problems in a moment. Before we do, let’s clear up a couple of other points. I agree that going global is important if for no other reason, than it gives Canadian investors exposure beyond Canada’s borders. Like it or not, the Canadian equity market represents less than 3% of the world’s equity. So despite the fact that Canada was the place to be over the past three years, you will have to bury your head in the sand, if you think it is the only place to be going forward. 

Mr. G.B’s comment on the costs associated with global investing is to a large extent, correct. Global funds tend to have higher MER’s. However, there may be good reasons for the higher cost. For example, Canadian mutual fund companies tend to outsource the management of their global funds. Often to a team of managers in various regions of the world. That expertise can be expensive. 

Another factor that can affect Canadian based global funds is the cost of hedging currency risk. Many investors find that option attractive, because it removes or reduces the negative impact that a strong Canadian dollar can have on the performance of global assets. But like all aspects of investing, hedging comes with a cost. 

Mr. G.B’s view that ETFs are a low cost solution assumes that all ETF’s are passively managed index funds. And while there are many index based low cost ETFs, there are also many actively managed global ETFs, and their MERs are not significantly different from the MERs associated with traditional global mutual funds. Cost then becomes an issue around indexing versus active management. The trick is to understand the costs, and evaluate whether the added costs are a benefit. 

Back to Mr. G.B’s other points; 1) “The selection [of global fund] available in Canada is very limited and 2) ETF’s purchased on the US exchanges are subject to currency conversion fees when purchased within RRSPs. This is a significant cost for the average retail investor where the bulk of the portfolio is held inside the RRSP.” 

Clearly we do have a limited selection of Canadian based ETFs that invest globally, which is why Mr. G.B. talked the wide variety of global ETF’s listed on the American Stock Exchange (www.amex.com). 

The issue around currency conversion comes from the fact tat RRSPs are Canadian dollar denominated accounts. As such, you must convert your US based ETF’s into Canadian dollars when held inside RRSPs. 

So far, the brokerage industry has not made any effort to design a platform to hold RRSP assets in a currency aside from Canadian dollars. This is an issue we have tackled in this column previously, and if readers want a refresher, archived Portfolio Matters columns can be found on my website www.croftgroup.com. 

Having said that, currency is not a significant issue if you are buying and holding ETFs inside RRSPs. The main impediment to trading foreign denominated assets in RRSPs is the frequency of the trading. If you are moving in and out of a security many times during the year, currency conversion costs become prohibitive. 

While on the subject of RRSPs, another reader, Mr. R.B, sent an e-mail that discussed in length how he systematically removes securities from his RRSP to minimize taxes. He writes; inside RRSPs “all gains are ultimately treated as income compared to capital gains on assets that grow outside an RRSP.” Given the real difference between 50% (tax payable on capital gains) and 100% (tax eventually payable on RRSP withdrawals) times the marginal tax rate, there is a point where compounding inside the RRSP is irrelevant in comparison. 

To state the obvious, investors need to clarify in their mind whether one should hold investments that typically produce capital gains and dividends outside RRSPs, and hold fixed income instruments that produce interest income, inside RRSPs. That’s where a financial plan can be a useful exercise.

The second reason for taking assets out of the RRSP sooner than later, is the claw back provisions in Canada’s social safety net. Says Mr. R.B. “I am now retired and living on pension income, investment income and minor consulting employment income. When I hit 65 next year my retirement income will be boosted by CPP and OAS. Any RRSP income or withdrawals over a specific limit will affect the claw backs.” 

That leads to another interesting fact; many 65 year old Canadians are in higher tax brackets than when they made their initial RRSP contributions. This is relevant, because it is polar opposite to the model that most investors bought into when they set up their RRSPs. A model that always assumed a lower tax bracket when you begin withdrawing from your RRSP. 

In such cases, some retirees would have been better off investing after tax dollars in appreciating investments over their working career than taking the short term RRSP tax benefit available at the time.

Mind you, the latest moves by the Federal government to allow income splitting of pension income – which RRSP payments would be considered – may help with the claw back issue. But, it is still important to be mindful of the claw back issue and deal with it sooner than later. As Mr. R.B. says, “he intends to withdraw from RRSPs before he gets social benefits and then after the fact, at a time and rate that minimizes the claw back.” 

All of this leads to a single important question; why were these factors never explained to us by those marketing RRSPs? Writes Mr. R.B.; “please tell this story.” 

To which I say, you have, and we will.