Why Real Estate Shouldn’t Be Your Only Retirement Plan

Your retirement plan should include more than real estateCanadian real estate has been on an absolute tear the past few years – and it’s about to experience another coming-of-age issue. With baby boomers set to retire en masse over the next decade, they are increasingly relying on the sale of their biggest asset, their home, to fund their retirement.

While owning a home offers many benefits – shelter, forced savings, and tax-free investment – relying too heavily on it can be a risky strategy. Canadian real estate prices can’t go up forever. As the saying goes, all good things come to an end. Let’s take a look at the risks of investing solely in real estate along with some good retirement plan investment alternatives.

 Real Estate vs. Bay Street

Investors are still recovering from 2009’s post-recession conditions. Since then, real estate prices have continued to climb, while the stock market took the biggest nose dive since the Great Depression. While 2009 may have been a terrible year for investment returns, it’s important to think long-term. Canadian real estate hasn’t fared as well as you’d think long-term. While the benchmark TSX returned an average of 5.45 per cent from 1981 to 2012, real estate was only slightly better – the average Canadian home price provided an annual return of 5.6 per cent.

While investing in the stock market can be risky, so too are real estate investments. If many baby boomers sell their houses at the same time, there would be an abundance of houses on the market, causing house prices to fall. Downsizing from an over-sized family home to a condo may not be as easy as you’d think – many retirees forget about the closing costs involved (land transfer tax, lawyer fees, etc.). You may also have to pay rent and maintenance fees to your new residence. Real estate is the classic example of putting all your eggs in one basket – you can diversify through asset allocation in your investment portfolio, but you can’t with your principal residence.

 Why RRSPs Pose Less Risk

Registered retirement savings plans (RRSPs) remain the most popular choice for Canadians saving for retirement. In 2010 Canadians contributed a total of $33.9 billion to their RRSPs. What’s not to love about RRSPs? You receive a tax refund, you can hold almost any type of investments and you can carry forward any used room from previous years. Just keep in mind that if your income is higher in retirement you could end up paying more tax and have government benefits like Old Age Security clawed back.

Locking In With GICs

Guaranteed investment certificates (GICs) are a safe and secure way to save for your retirement. GICs are as risk-free of an investment as they come – 100 per cent of your investment is guaranteed. GICs come in all shapes and sizes, although your money is typically locked-in for a set amount of time, such as one to five years, at a set interest rate. GICs do have their downside – interest is taxed the highest and your return might not even keep up with inflation.

 Should You Consider Mutual Funds?

Instead of owning one stock, how would you like to own a piece of the entire stock market? Mutual funds allow investors to spread their risk by owning a collection of stocks at a low cost. Mutual funds have many advantages – diversification, professional management and liquidity. Mutual funds aren’t without their downside, however – fees in the form of Management Expense Ratios (MERs) can eat into long-term investor returns.

 Taking a Chance on Bonds

Bonds are similar to stocks; you’re loaning money to a lender, typically a company or the government. Unlike stocks, instead of owning a piece of a company, you’re only lending money. A bond is purchased at a discount; on the bond’s maturity date you receive the bond’s face value. Bonds may sound great, but they aren’t without their risks – issuing companies can default and interest taxed least favourably.

Whatever you choose to invest in for retirement, just remember the cardinal rule – don’t put all your eggs in one basket. With a well-diversified portfolio you’ll have a better chance of meeting your retirement dreams.

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One thought on “Why Real Estate Shouldn’t Be Your Only Retirement Plan

  1. GICs? Seriously? Your money is “guaranteed”, sure — to go down in worth. Inflation is current higher than the measly interest rate paid. Maybe in a several years it’ll be different when interest rates return to something closer to historic norms, but right now you simply cannot “invest” in GICs, not when the purpose of investing is to grow your money. GICs currently do that only marginally better than sticking your money under your mattress and hoping the bills will spontaneously reproduce.

    I’m glad you did mention mutual funds, however. You wrote, “Mutual funds aren’t without their downside, however – fees in the form of Management Expense Ratios (MERs) can eat into long-term investor returns.” This is very true — except you then neglected to write anything else.

    Why not actually try to educate people a little more on the subject by adding a single sentence:

    “To minimize the bite of MERs, looking for funds with the lowest MERs may be wisest, such as index funds based on indices like the famous S&P 500, NASDAQ, TSX 100, etc., which attempt to capture the motion of the entire stock market rather than placing bets on individual stocks.”

    I realize that ETFs are probably a bit beyond the scope of the article, but perhaps a single throwaway line?

    “Exchange Traded Funds, or ETFs, are a type of mutual fund that have even lower MERs than mutual funds and, as they’re traded on the stock market, have no fees beyond your normal stock trading charges.”

    I realize that mentioning Vanguard’s ETFs would be a bit beyond the pale for you, so don’t worry — we won’t. 😉

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