I have developed a relatively straightforward heuristic for figuring out your RRSP.
heu·ris·tic adjective
Google Dictionary description
enabling a person to discover or learn something for themselves.”a “hands-on†or interactive heuristic approach to learning”
It is a simple trickle-down or waterfall decision tree. I often get asked this question or see it float by on other sites.
Where to Put Money Heuristic (not just RRSP)
- Pay off debt , it has the highest guaranteed payback today.
I mean all debt except perhaps your mortgage. A mortgage is your most considerable debt, so my view is investing elsewhere and not paying down your mortgage is a mistake. I have been told my opinion is very “old fashioned”.- This lowers your risk in life and gives you choices.
- This lowers your risk in life and gives you choices.
- Put money in your TFSA.
My opinion is that this is a good place to put your money. How you invest it, is up to you. It should be within your Risk tolerances. Whether you want to buy stocks, Index Funds, ETFs or mutual funds is up to you. Do this in a trading account. In a trading account you can buy all those savings vehicles. In a Mutual Fund account, you usually can only buy Bank or Insurance company (read high MER) funds.
TFSA until you reach your limit. You find that in your My CRA Account (limit as of the start of the current year). - Do you have Kids? If you do, maybe it is time to think about an RESP? This could be, before (2). The Registered Education Savings Plan will help your child’s future. You may decide you don’t want to do this, so you could skip this step.
- Do you have a disabled loved one? Before step (1) you might want to think about an RDSP. A Registered Disability Savings Plan will help their future a great deal.
- Time to use your RRSP. It will lower your tax levels, so you should reinvest the money you get back into the RRSP, until you have no RRSP limit left.
Sometimes you can’t use your RRSP, if you are lucky enough to have a Pension. This is a tragedy of riches, so don’t complain to your friends about it, or they might kick you in the shins. - You have reached savings nirvana. If you are at this point where:
- All your debt is paid off
- Your TFSA limit is reached
- Your RRSP is full
You are now at the Zen level of life.
You have choices that most folks don’t have at this point in your life. Your Risk level should be pretty low. Your stress level (due to money) should be non-existent.
This is your goal. Being out of debt with money in the bank means you are financially in the right place. You can do what you want.
Am I Done ?
If you somehow get back into debt, restart the process. You did it once. You can do it again. Maybe create (say after step (1)) an Emergency Fund if something terrible happens.
Is this easy? No, however, it is a good heuristic.
smayer97 my point has nothing to do with risk per se. The discussion is regarding borrowing to invest and my point is that people make the decision to borrow to invest in real estate with the belief that the rent will cover/subsidize the mortgage payments. They do not factor in things like tenants losing their jobs or tenants just not paying into the equation. You state:
“I actually do not advocate buying a house at all using a mortgage (and strongly suggest someone think long and hard beforehand)”.
I totally agree with the thinking long and hard but the problem is many people don’t understand mortgages, risk, etc. well enough to make an educated decision. What happens is people get house fever, and believe that a mortgage is “good” debt. I realize the COVID19 scenario is unprecedented. My family will often accuse me of being an “awfulizer” by laying out the worst case scenario in every decision. But even I wouldn’t have gone to this level of crisis. My point is that when people think a mortage or borrowing to invest is “good” debt, they are ignoring the actual risks.
“My point is that when people think a mortage [sic] or borrowing to invest is “good†debt, they are ignoring the actual risks.”
It may be true that SOME do not consider all the risks but ANY person entering into ANY form of investment needs to consider ALL the risks. So your conclusion is false…
To claim that A is bad (using mortgages for investing) just because B is bad (some ignoring actual risks of mortgages when investing in real estate) is not a valid conclusion because A is not what makes B bad and B is not what makes A bad, other arguments notwithstanding.
Anyone ignoring the actual risks of any investment is just being foolish and not performing good due diligence, regardless of the investment.
Well said. And yes, it is often foolishness that leads people to make poor choices.
Looks like great advice to me. But then I am, like you, old-fashioned.
Thanks for the thoughts. Some comments…
I would argue that all ‘consumer’ debt is bad. If you have debt that is generating income, then the analysis should include the risk of exposure to that debt, e.g., increasing interest rates, risk of not covering cost from decreasing revenue, risk of loss of debt capital. In other words, not all debt is bad.
When it comes to TFSA vs RRSP the one factor to consider is whether you expect your future income after retirement to be higher or lower than it is now, in simplistic terms. If you expect it to be higher, then investing in a TFSA first is better, since you would have paid your taxes on the income at a lower marginal tax rate and money taken out of the TFSA is tax free. But if you expect your income to be lower, then investing in a RRSP first is better since you would pay tax at a lower marginal tax rate when you withdraw the money from the RRSP, and in the meantime you get to grow your money with a larger starting base.
When it comes to RRSP vs RESP and/r RDSP, a factor to consider is that with an RESP you are growing the money with additional money from the government. And if you do not end up using the funds for education, you can pull out the money invested, return the portion from the government, BUT you get to keep and transfer your earnings from the RESP/RDSP to an RRSP. And you are not limited to setting up an RESP/RDSP just for your kids but also grandkids. And especially with RDSP’s you can get up to 300% extra money to grow the plan. This works best with self-managed accounts as you avoid management fees and maintain a lot more flexibility getting in and out of the plans.
Just some thoughts.
The new exciting view on debt is that if you build wealth with debt, it is good. I don’t agree, but I have also seen enough collapses with those sentiments, to make me jaded.
I hear you and I tend to agree. But if that were entirely true, you would not advocate the exception of paying down your mortgage.
Yet that is one example where debt can be used very effectively, such that if you have a rental property or are renting out part of your residence your risk is low. I know first hand because we have achieved covering not only the debt cost but have excess to cover all our life expenses from our properties, such that we are effectively living “rent” or cost free for almost 20 years.
There is no such thing as risk free anything… even keeping cash in the bank has the risk of losing money to inflation, or worse, the folding of the bank (CDIC insurance notwithstanding), just for starters.
My point is that of knowing where your risk is and managing it with healthy margin. I would say that this is not for everyone.
Well my perspectives on this is:
If you are looking to “build wealth” and all that other hokum that financial writers attempt to sell, this is not where you should be reading.
I do want to point out that I at first was commenting on the whole article on each part. But since the focus is on the mortgage part, would it not be true that when you get a mortgage you are “using debt to grow wealth”?
After all, a big part of the decision to buy a house forcibly involves borrowing for the vast majority of people in this day and age and is really about the rent-vs-own discussion, which is about reducing expenses and increasing wealth.
That is kind of what I am partly alluding to. Otherwise, the advice would have to be to not ever buy a house unless you have the money (ideal maybe but highly unrealistic for most, especially in bigger urban centres). And then this discussion would be moot.
Anyway, not trying to be contentious but simply to point out that the discussion around this is a little more complex.
P.S. Just to be clear, I actually do not advocate buying a house at all using a mortgage (and strongly suggest someone think long and hard beforehand) unless there is a real significant, tangible and manageable financial advantage, which for many people, it is not because of the heavy burden. In our case, we made sure of that.
“if you have a rental property or are renting out part of your residence your risk is lowâ€
Unless there’s a worldwide pandemic and your tenants lose their jobs and you can’t evict them because the government is protecting them. But that will never happen.
So much to unpackage there.
What’s you point Susan?
I know first hand, since I am a landlord. Low risk does not mean NO risk… there is virtually nothing with NO risk in life, especially when it comes to the investment world …