3 RRSP myths

The mythology of the power of RRSPs is really an accumulation of several claims that have built up over time. Let's look at each in turn.

1. Start yesterday
Here's the claim: If you want to retire in comfort, you have to put money into your RRSP every year, and it's best to start when you are young. The younger the better. If you start an RRSP when you are just 22 years old and you put $4,000 in per year until you are 65 at an annual rate of return of eight per cent, your RRSP will be worth $1.3 million when you retire!

I am tired of hearing this pitch because it's really nothing more than a slick marketing trick that can be lethal to your financial health. There are many problems with it.

First, consider who is sending the message. It's all the usual suspects: banks, brokerage houses, and most "financial advisers." Why do they want you to fall for this message? Because for every dollar you put in, they get a percentage. It's a guaranteed annuity for them, regardless of what happens to your investments along the way.

When you hand over your money to your adviser or banker to invest in an RRSP, he or she will do as you ask and invest it for you. If he or she invests in a mutual fund, in addition to any upfront commission, he or she will also get a fee from the mutual fund company. You will never know how much your adviser or banker is getting, however, because this cost is buried in the expenses of the mutual fund company. This cost is included in the management expense ratio, or MER. It represents the ratio of costs, including commissions and marketing expenses, as a percentage of the total assets of the mutual fund. All investors in that fund are paying those management expenses, and it can all add up to a lot of money.

For example, say the managers of the mutual fund were able to realize a return on their investments of seven per cent. If the MER is two per cent, the overall rate of return on that mutual fund would be only the net amount of five per cent. The theory is that the managers are being rewarded for generating above-average returns. That's fine if they do indeed generate that kind of return, but in many cases they don't. Your broker and the mutual fund company win. You lose.

The second problem with this claim is that it ignores some basic facts of life. Where is the typical 22-year-old going to come up with $4,000 per year? He or she has possibly just graduated from university and perhaps has a student loan. As with any debt, that loan will have a fixed interest rate that in many cases will exceed what can be earned in the RRSP. Nor should a 22-year-old borrow the money to invest in an RRSP. Increasing debt at this age is the last thing anyone should be considering. No one is even allowed to invest in an RRSP until he or she has a job or other earned income to create RRSP contribution room.

Lastly, does it make sense for a 22-year-old to be worried about retirement? In every stage of life, you need to set your priorities both personally and financially. What about seeing the world and enjoying some life experiences before settling down to marriage, kids, a home and all the rest? Frankly, I don't think focusing on retirement from the day he or she gets out of school is the best advice to give a young adult!

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Excerpted from Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams by David Trahair, CA. Copyright 2004, 2007 by International Self-Counsel Press Ltd. Excerpted with permission of Self-Counsel Press. All rights reserved. No part of this excerpt may be reproduced except with permission in writing from the publisher.