RRSP Investments and the benefits of compounding rates of return (DRIP)

Each investment opportunity carries its own set of risks, and one major factor among these is market volatility. Market cycles range greatly depending on the type of investment, and the variation of volatility swings depending on the market and investment.

Both macro and micro fundamentals should be considered when evaluating an investment opportunity, and this couldn’t be more applicable than in the real estate sector.

In terms of the market outlook, Stephen Poloz, Governor of the Canada-UK Chamber of Commerce, has a positive forecast for the Canadian economy. In his projections, he anticipates annual growth rates to hover around 2% over the next couple of years and stability to markets returning especially following the arduous trade negotiations between Canada and the US. Fears are somewhat quelled and investor confidence seems to return to a comfortable level.

Regardless of the rate of return on an investment, additional income can be squeezed from reinvesting that same return. Many investors underestimate the power of compound interest mainly because it works best in a well-performing market.

When the market is performing you earn more, but when it reverts into a downfall, you might not want to stay there. The good thing is there are certain ways to benefit from compounding rates of return in any given market condition.

Fixed dividend paying investments can generate potential compounded interest. If you are among those investors looking for safer and better ways to get the most of your money and save up for retirement, you may want to consider utilizing your RRSP.

Why RRSP?

According to the Canada Revenue Agency (CRA), you can make use of your RRSP and put it into several types of qualified investments. The CRA permits you to buy, sell and hold equities, stocks, bonds, mutual funds, ETFs, index funds, and even mortgages.

Nevertheless, your RRSP is not only trying to let you save up for retirement, tax deferred, but also helps you earn interest, dividends, and even investment growth if you apply the compounding rule.

Mortgage Investment Corporation (MIC)

Dividends reflect business performance, rather than investor sentiment or speculation. It could also offer higher growth opportunities and compound interest without significant market risks. Among the qualified investments allowed in RRSPs, REITs and MICs are amongst the most common investment vehicles to enjoy the benefits of compounded interest.

These two investment streams are obligated to pay a dividend to all their shareholders yearly at a targetted rate in the forms of cash, cheque, deposits, and even reinvestment.

Once you start earning dividends, you can opt for reinvesting it to the same MIC to gain more potential income and growth. Dividend reinvestment plan (DRIP) could be your ticket to a million dollar retirement savings. MICs can magnify your chances of long-term investing success.

You can scale your investment growth quicker by reinvesting instead of opting for cash dividends. Through reinvesting, the overall investment increases to its highest possible rate due to the effects of compound interest. MICs can add an element of diversification in your portfolio and help you manage risk.

DRIP Benefits

DRIPs can have immense benefits if well-planned. The most important thing is to pick a strategy – or better yet, a mix of strategies – that works for you. Don’t just settle for approaches you think that worked for others, you need to do your due diligence or better yet, consult with an expert for professional advice.

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DRIP provides investors with the following advantages:

  • Commission-free. You can save a lot on commission fees because you are reinvesting on the same company. Small-time and first-time investors don’t need to keep large amounts just for brokerage fees.
  • DRIP uses the dollar-cost averaging system. If the share price drops, your dividend can buy more shares. This system ensures you stay and keep on investing and reinvesting even when the market is fearful; the market’s movements have a slight effect on how you spend. Those investors using their RRSPs opt for dollar-cost averaging, expanding their investments out over a period instead of taking the fall at one time.
  • Compounding returns. In the long run, Investors who opted for DRIPs end up owning a greater share or percentage of the investment vehicle.

Time is the key to accelerating the income potential of your principal investment. You need to be patient enough before you can enjoy financial freedom. Apart from that, DRIP teaches a valuable lesson of controlling your emotions, especially during economic downfalls.

Starting young and investing more can also significantly provide you with exceptional DRIP advantages.

DRIP Tips

DRIP is not for everyone. It is an attractive option for long-term investors who have a longer-term outlook. Invest in well-established companies, with a consistent track record of performance with little volatility from year to year.

Drawbacks

Depending on the investment vehicle, the reinvestment may acquire additional shares at an inflated price if the share or unit prices are subject to market movements.If investing through an RRSP while utilizing a DRIP program, investors are able to defer taxes on their dividend earnings. Reinvesting the full dividend amount via a registered account allows you to grow your investment while postponing your tax obligations.

In numerous ways, DRIP or share repurchases, are better than cash dividends. However, DRIPs vary from company to company. Some may allow shareholders to buy shares based solely on their dividends, while others enable optional and additional cash purchases on top of the dividend reinvestment.

Invest wisely

There are no guarantees with investing. You could get back less than you invest but that risk can be hedged through the careful research conducted to seek out an investment option that provides an opportunity for investors to participate in an investment that offers stable or fixed returns coupled with an RRSP investment option. If a DRIP investment option is on the table, then that can propel your compounding growth to a greater extent.

Don’t underestimate the power of your retirement savings plan. If you apply the power of compound interest, you can look forward to achieving your financial goals that much sooner. Check out our free compound interest calculator to see how much sooner you could achieve your financial goals.