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Canadian investors have plenty to think about this RSP season. Last year’s federal budget removed the foreign-content restrictions for registered savings plans. Previously, you could hold only 30% of your RSP’s book value in global investments. Today, there are no limits. The best way to proceed in this environment is to find the right amount of foreign exposure for your portfolio, and then decide on the best way to invest globally. Here are some things to keep in mind.
Why go global
Most investors understand the importance of building a diversified portfolio — one that includes some equities for their growth potential, some bonds for stable returns, and some cash for security. A diversified mix is one of the best ways to reduce market risk and increase potential returns over the long term.
But that’s just the first step. It’s also important for Canadian investors to diversify their portfolios geographically. That’s because our market represents only 3% of the world’s investment opportunities. If you were to limit your RSP to Canada, you’d be exposed to the fortunes of one small market.
What’s more, because Canada’s stock market is heavily concentrated in the resource and financial sectors — which together represent more than 50% of our market — you may miss out on potential opportunities by staying too close to home. For instance, the health care, information technology, and consumer sectors are better represented in the U.S., Japan, and Europe than they are in Canada.
Look beyond the United States
Many Canadian investors diversify their investments with U.S. stocks and mutual funds. This is natural enough, given our proximity to the U.S. and our familiarity with its big companies. While having some exposure to the world’s largest market makes good sense, it’s also important to look beyond the States.
That’s because the Canadian and U.S. markets are highly correlated, meaning that they tend to move in the same direction at the same time. Adding exposure to markets that aren’t as correlated to North America’s — such as Southeast Asia, Japan, and Europe — can help to reduce overall risk in your portfolio.
Currency movements are another reason to diversify abroad. By holding investments denominated in different world currencies, you can reduce the impact of currency fluctuations on your overall portfolio.
How to go global
There are many ways to add global exposure to your investments.
The mutual fund route. For most of us, mutual funds are the easiest and most convenient way to go global. You gain broad diversification and professional management, and can choose from funds that invest in a particular country, region, or market sector.
Portfolio funds. These one-stop investment solutions typically combine a number of mutual funds that represent all the major asset classes — cash, fixed income, Canadian equities, along with U.S. and international equities. All you need to do is choose a portfolio that matches your investor profile (from conservative to aggressive). The day-to-day investment decisions and portfolio rebalancing are taken care of for you.
U.S. and international stocks. Self-managed investors can purchase U.S. stocks the same way they do Canadian stocks. They can also conveniently buy the shares of many large foreign companies that trade as American Depositary Receipts — which represent shares of international companies that are held on deposit by U.S. banks, and that trade on U.S. exchanges in U.S. dollars.
Exchange-traded funds (ETFs) are another way for self-managed investors to diversify their portfolios. ETFs are index-based investments that track a number of U.S. and international market indexes.
What’s right for you
Although there are no set rules for how much global exposure you need, many investment experts recommend a level of 20% to 30% for your RSP. More enterprising investors might even decide to go beyond that level. As always, the right amount for you will depend on your goals, risk tolerance, and time horizon.
Most financial institutions have tools that can help you determine your investor profile, and then select the appropriate investment mix that’s right for your objectives. Speak to your financial advisor about the best way to enhance the global reach of your RSP.
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