Buy an RRSP or pay down the mortgage? There's no question (BY GARTH TURNER)
There are just a few days left in RRSP season-that time of the year when financial anxiety tops even the sex drive for most people. One of the most frequent questions I am asked, usually by younger people, is this: the RRSP or the mortgage?
Traditional thinking has been that the holy grail of personal financial planning was to pay off the mortgage, then in later life worry about building retirement assets. But that assumed some conditions that don't exist today, namely increasing house prices, high mortgage rates and rising inflation. So, the thinking has changed.
One good strategy for the cautious would be to make the maximum RRSP contribution (even if you have to borrow money), and then use the refund cheque Ottawa will send you to pay down the mortgage principal. If you combine that with techniques to accelerate debt repayment (like a weekly-pay mortgage), you can build up equity faster and still be contributing to the RRSP.
But there is something else to consider. Real Estate has been a storehouse of value over the last year, but it has not been appreciating in value. At the same time, mortgage rates have slumped to the lowest point in three decades (and will go lower next month) and financial assets are giving double digit returns. That means young couples should not sacrifice building their non-real estate assets on the altar of mortgage reduction.
When you can get a mortgage for six per cent and easily earn a 12 per cent return within a tax free RRSP (invested in equity-based mutual funds), then it makes more sense to be pumping cash into RRSP's than the mortgage. Of course, the interest on the home loan is non-deductible and that means it should be paid down over time.
But if housing keeps on doing what it has so far this decade - which is not much of anything in terms of price-then why the heck should you keep throwing money at it? For many recent buyers, there will likely be no capital gain when the property is sold. Meanwhile, these are the fat years for financial assets - when the returns are high and the risk relatively low. Young investors have the greatest of advantages: time.
Remember that $100,000 put into Templeton Growth 20 years ago grew into well over $2 million. The same in Trimark Fund became almost $600,000 in 15 years. And cash put into Fidelity Growth America Fund or Investor's Group U.S. Growth more than doubled in five years.
Do not forget Garth's Golden Rule: Time defeats risk. The further you are from retirement, the more valuable are you RRSP contributions because of tax-free compounding. Will $100,000 in real estate equity turn into $2 million in 20 years? If you have faith it will, feed the mortgage. If not, don't let the mortgage eat you.
And speaking of investing, if you've been thinking dabbling in one of those new federal RRSP Bonds, don't. These are about the worst investment vehicles I have seen and shame on the feds for trying to hoodwink us so they can mop up our retirement dollars.
The bonds are cashable once a year and pay interest that starts in year on at just 2.75 per cent. That is outrageous at a time when inflation is 2.2 per cent. It amounts to giving up your money for no return.
Of course, Ottawa says your rate will escalate all the way to more than eight per cent in year 10, but that just means the average yield for a decade-long investment is 6.01 per cent. If you think tying up your money for 10 years for six per cent is a good financial plan, you are in serious trouble. Or, you will be. The greatest risk facing Canadians is not losing money in an investment that goes down, it's investing turkeys like these bonds that just about guarantee you will outlive your money.
And particularly offensive is the $2-million ad campaign for these bonds, with TV spots showing a middle-aged man with a house in the suburbs and a minivan, snow-boarding and skydiving off a dizzying rock face. The message is clear: Throw your body into the arms of death, but never take a risk with your money.,
Geez. Maybe the feds should concentrate on rescuing the Canada Pension Plan instead of stealing our RRSP money.
REAL ESTATE WATCH
BY GARTH TURNER
FROM: TREB Newspaper Feb 14.97
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