It's RRSP season and there are only a couple of weeks left to invest some cash to reduce your taxable income for 2009. Many people are looking for advice on how to spend any extra funds. Some ideas are coming out from so-called 'financial advisers' that are giving out, frankly, really bad advice. Take for instance this article from Yahoo! Finance Canada that suggests it's better to pay off your credit cards over investing in your RRSPs, and investing in TFSAs over RRSPs.
None of that is bad advice necessarily, but within the good advice are some sketchy ideas. Be sure to look at a number of sources when researching online folks! And be sure to chat with a financial advisor that provides instruments from a variety of companies rather than say, a bank who are obligated to offer primarily bank investments.
With these ideas in mind, let's review some reasons why forgoing RRSPs today will cripple your retirement in the future.
One of the main ideas from the Yahoo! article stemmed around reducing personal debt before considering long term investments.
...consumers with substantial credit card debts shouldn't get a loan to make a contribution to their registered retirement savings plan, with the hope of paying off the money borrowed with anything that comes back in the form of an income tax refund.
Yea, well that makes sense, pay off your debts, especially the high interest bearing credit cards. But what they say next misses the mark.
But whether you should or shouldn't contribute to retirement savings - and how much - always depends on age and personal situations.
A 25-year-old with $25,000 worth of debt could forego making RRSP contributions for a couple of years with the goal in mind of paying off the debt as quickly as possible.
On the other hand, a 40-year-old with credit card debt needs to put at least some money into an RRSP and the rest toward paying off what's owed on the charge cards.
Yes, paying debt off is great, but no, investing in RRSPs later on in life isn't prudent. Why?
Simply put, if you use an RRSP as a primary vehicle to get out of paying more taxes then you've completely missed the point. RRSPs reduce taxable income in the year they're used, but they also accrue interest throughout its life until you cash in.
You're supposed to be treating RRSP's as your retirement savings, which is a no brainer. Now stick with me h ere: in order to maintain your current lifestyle you'll need millions of dollars upon retirement. That means your RRSPs aren't going to be GIC or some kind of low bearing interest instrument, and your RRSPs are going to be invested for a longer period of time.
The greatest asset to any investment will be time. TIME will ensure you can retire with more cash (and even retire at all). To NOT invest in your early 20s is to forgo CRUCIAL earning years later in life. If you start investing in RRSPs when you're 40 you will make significantly less even if you accrue over 15% returns annually.
I can understand the need to reduce consumer debt, but the fact remains, debt is an issue of spending by t he consumer, and that's a problem you need to fix. Spending behaviour, however, doesn't change how the market work, and the market accrues interest, and when compounded, will make the bulk of the money at the END of the investment.
So what about TFSAs? How are they int he mix? Fact is you can have the same kind of investment instruments be it in a RRSP or TFSA. The trick is the balance between reducing taxable income this year (RRSP) and investing into a un-taxable account like the TFSA.
Best case scenario is use both. Pay less taxes today and also invest in your TFSA.
But let's go back to the initial question, what should you pay first? Credit card debt or investments?
Credit cards charge huge amounts of interest. If you're stuck in a situation where you're constantly paying off CC debt then you have a fundamental SPENDING problem and will never be able to reach financial freedom because of your inability to be responsible with your money. It's sobering, but the warning is necessary.
"The message should be: First pay down your debt. When you go ahead and try to save for retirement when you're saddled with debt, you are skipping steps,"
This is true, however, fundamentally what needs to change are spending habits. You MUST save not 'try' to save for your retirement. There is no chance that the next generation will be able to rely on a company pension (if one even exists) or government help to live above the poverty line. It's CRUCIAL to save tomorrow or you'll be picketing at 70 for more money to live and buy meds when in reality it was your job to ensure your own financial safety.
Save for your future. DO what needs to be done to eliminate all credit card debt, focus on a balance between your TFSA and RRSPs, come out ahead when you retire. Remember, the single most important factor to your investments is the elements of TIME.
Time is the most important factor because it's in the last years of your investments that you'll have your greatest earning years from your investments. Compound interest will increase on a increasing curve in the latter years.
That means if you're young there is NO REASON to invest long term investments in low and safe investment instruments. RRSPs for a young 20 something should never be in a balanced or GIC fund. Focus on the higher risk but long term reward of equity funds.
When you're getting up in years you unfortunately lose out on the benefit of growing investments from compound interest. You'll also want to hedge your bets by putting your savings into more secure and less volatile investments like the aforementioned GICs and balanced funds.
The conclusion is quite simple. Young people must control spending AND invest for their future TODAY. Earlier is unequivocally better thus control your finances so the money you could be putting away for your retirement doesn't go to your new Wii and jeans. Anybody who mentions something else isn't looking out for your best interests.
If you don't believe me then sit down, take out a piece of paper and decide what the best case scenario for your investments will leave you with at age 65. Calculate all expected expenses for that time over a monthly period and divide it out. Many people will be alarmed to find out they'll have to work till they're 80 before they can retire comfortably.
It's your call, some prudent decisions today to maintain a basic quality of life tomorrow. That's what's at stake.
