Check your mail box today to see if you have the latest edition of Moneysense magazine. If so jump to p.14 and Duncan Hood's column on RRSP or Mortgage? If you don't have the magazine, I'll do a quick summary.
Mr. Hood suggests that the 'debate' about paying off the mortgage vs the adding to your RRSP is over for a few good reasons. First he explains the misconception that your RRSP is tax sheltered while your RRSP is. Obviously if you put money in the RRSP you get a cheque back from the government, but if you pay off the mortgage you pay less interest. So all those future payments will have less interest paid with after tax dollars, so in effect your not only saving the interest, but the tax on all that interest too.
Then Mr. Hood goes on to say it's about risk. A mortgage at 6% is a guaranteed returned, while a 8% mutal fund after the average 2% MER (management expense ratio) gives you the same return, but your exposed to the market risk. So obviously then we should pay down our mortgages first and then contribute to our RRSP.
Ok, I agree with his first point. Saving lots of interest on the mortgage is a good thing. It's the numbers in the second point I'm having problems with. First off most intelligent investors are not paying a 2% MER on anything. If you even use the basic couch potato portfolio you would have got a return last year close to 12% with a MER around 0.5% (or less), for a net return of 11.5%. I locked in my mortgage back in the very low interest days and blended in my new portion when I moved, so I'm only at just over 5%. So my RRSP is 6.5% higher than my mortgage, which in my mind is worth some risk.
The problem with these little articles is they make assumptions. The reality is the answer of paying off the mortgage or save for retirement depends on your own numbers and your comfort level with risk. If your like me a higher RRSP return makes me more likely to save for retirement, but I'm also aware that your mortgage is a reverse compounding curve. So any payments in the first five years really drops your interest payments over the life of the mortgage. So my answer is do both. I've increased my mortgage payments by 15% to assist on the pay down, while still putting a fair amount into my RRSP's. Then any left over cash is getting saved for a big payoff to the mortgage in another year, because if I want to retire at 45 I need to get rid of my mortgage a bit faster than normal. So in the end, do want's right for you.
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7 comments:
CD,
Remember that when you pay down your mortgage, you are using AFTER TAX dollars. So before tax, your 5% mortgage is really a 6-6.5% return when you pay it down. I think the appeal is that you have a 6.5% return RISK FREE.
Some food for thought.
FT
http://www.milliondollarjourney.com
I agree with what you're saying in that it's likely best to balance between mortgage repayments and RRSP savings. I think one thing you're missing is that your 12% returns last year are far from average. When you have a -10% year, that quickly reduces your average. I believe the long-term average expected return at medium risk is around 8%. For a conservative investor, this drops to around 6%.
FT,
I agree. I should adjust the rate of the mortgage for after tax dollars.
jmackey,
Yes a 12% return is not typical. I just grab the nearest return statement for a year that I had handy. Obviously a -10% return would kill your average, but that's the risk of being in the market. I just pointed out that a hybrid approach works well for me.
CD
One more thing to note is the fact that how much you earn can determine the value of an RRSP from one person to the next.
Someone making $100,000/yr will see more value in an RRSP than someone making $35,000....no?
byno,
You are correct. Your income determines if there is any value to putting money into an RRSP. For example, if you are at $35,000 or less a year I would think you get no advantage in putting money in a RRSP.
CD
It's odd that I should stumble in here just after reading Duncan Hood's article online. At any rate, here's the link for your readers to view the article:
http://www.canadianbusiness.com/my_money/columnists/duncan_hood/article.jsp?content=20070205_113452_4772
Hopefully the link doesn't expire any time soon. Good luck to all in your financial goals!
Whoops, sorry! I'll have to shorten that URL.
http://tinyurl.com/2tz2z3
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