It fascinates me, like watching an unwary insect zig-zagging towards a waiting trap-door spider, to hear people asking what is the correct way to invest. Listening to and reading the answers to their frantic questions makes me even more uncomfortable. I don’t believe there is any one, correct way to invest. There are just too many variables. I think most people would be much better off in they could just relax a bit. There are many paths up the mountain and the view from 9,789 feet up is pretty close to that from 9,804.
Should I Max Out my TFSA First?
This is a common question. The answer though is a moving target.
TFSAs were only created 5 years ago. So the first year they were offered, you could max your TFSA with a $5000 contribution. When the “max” was that small, the consensus answer was yes, max out your TFSA first.
Even in 2014, the maximum someone who is 23 or older that year can contribute to a TFSA is $31,000 and that assumes they have contributed nothing ever (or have withdrawn everything from every TFSA they have in 2013).
$31,000 is still an achievable number, so it may be a good idea to max out a TFSA first.
But soon, that number will climb up to $50,000 or higher. At what point do you start to contribute to an RRSP as well as a TFSA?
Instead of a simple answer, it becomes necessary to consider a variety of factors:
- What is your salary?
- What is the expected change in your salary over the next 10-15 years?
- Are you an impulsive spender?
- Do you intend to buy a home (house or condo, etc.) soon?
- Do you have debt? What kinds?
- Are you planning to marry soon?
- Do you have dependents (children, aged parents, disabled spouse, etc.)?
- What income tax do you pay?
I’ll have to discuss some of these factors in a separate article. This one’s about the many paths up to that peak.
Should I Max Out my RRSP First?
This is probably the second most common question. It becomes the first during “RRSP Season” from January to February each year.
Many answers were written before the TFSA was invented and those answers have not been updated to account for this new investment possibility. Be wary and check the date of the information, especially in books.
One of the most common errors I see is people saying “Wait to contribute to your RRSP until you’re in a high tax bracket.”
They don’t seem to understand that contributing to your RRSP (and reporting your contributions on your annual tax return) and claiming the deduction for your contribution are two different things.
I could contribute to my RRSP in June 2013. I would have to report the contribution, with receipts, on my income tax forms for 2013. But I could wait till 2025 to claim the deduction to reduce my taxable income and to reduce my payable taxes (and maybe get a tax refund!). I just have to fill out Schedule 7. I could even wait till 2035!
One of the most common errors of omission I see is people not saying “If you are in a low tax bracket and you will probably be in a low tax bracket all your life, it’s better to save in your TFSA because it doesn’t affect your OAS and GIS eligibility and payments.”
That’s right: the real kicker is for very low income earners. If someone is going to have income of less than $15,000 (in 2013 dollars) in retirement from their pension, CPP, interest income on their investments, etc, they do not want to have a RRSP. Money coming out of the RRSP will reduce how much OAS or GIS they are entitled to receive. Money coming out of a TFSA will not reduce those payments. (At least it won’t as the rules are written right now. My cynical side expects that to change in the next 20 years.)
I need to explain these things in more detail in a separate article as well. But again, what I’m trying to say here is that there is no one simple, correct answer for everyone. Each person is unique and the best path for each person will vary.
Should I Pay Down My Mortgage First?
Again, this one used to be a no-brainer. People bought a house with a 50%+ down payment. They had a 25-year mortgage and they had 30 years till retirement. The interest rate on the mortgage was 7%+ and the interest rate on their GICs was 5%. There were no TFSAs. Their Pension Adjustments (PA’s) were so large because they had defined benefit pensions that they could only contribute $2,000 or less a year to a RRSP. They swore to everyone that they only planned to leave their home “when they were carried out in a box.”
In their cases, yes, paying down the mortgage made complete sense.
Now people are buying homes with tiny down payments. Some homes cost 5-10 times their owners’ annual gross salaries. They are buying them with a 25-year mortgage and 10 years till retirement. The interest rates, though, are low. They plan to down-size, right-size, convert to a rental property, flip or sell them to developers looking to drop a huge in-fill house on the super-sized lot.
It’s no longer a simple: “Yes. Pay off the mortgage first.” answer.
Real Estate? Gold? Non-Registered Accounts? RESPs?
The internet and the “celebrity-style” investment reporting on most news networks has just increased the confusion. The media is always buzzing about making millions in real estate, protecting yourself from world-wide-economic-collapse buy loading up on gold, avoiding the convoluted tax implications of registered accounts by keeping simple and investing only in non-registered accounts, and even using your kids’ RESPs as tax shelters for personal spending funds for their parents.
So many choices, so much noise, so many ways to go wrong, lose money, not keep up with your peers, never get to retire, never get to travel, never succeed.
I’ll repeat myself:
- There isn’t any one correct way to invest. Many paths will lead to the same destination.
- You don’t have to “get it right.” There is no wrong.
- You don’t have to agonize and get paralyzed by all of the choices.
- You will not be judged and found wanting.
Pick a path. Practically any path. Almost every one will lead you gradually up the mountain slope.
Don’t worry so much. The paths all criss-cross multiple times on the journey up. You can switch paths. You can even send some of your investments up one path while the rest of them follow another.
There are only a couple of choices that you must make:
- Save money.
- Don’t stay in debt.
- Invest that money you save at a rate that exceeds inflation so it at least keeps today’s value.
Don’t worry about making the most possible profit from your money. No one knows how to do that successfully every time. Just try to make some profit and stop expecting perfection from yourself and your investments.
And try to tune out the endless stream of information that tells you “You’re doing it all wrong! Do it my way!” If you’re saving money, you’re doing it right.
Does it bother you to see people agonizing over whether to max their TFSA or buy a rental property? Please share your views with a comment.