Does your financial representative only contact you once per year (usually in January or February) with nothing much to say other than “Are you planning on making an RRSP contribution this year?” Well if it is, then you likely have an “old school” salesperson as your financial rep and that’s just one of several problems. It should be no secret that large financial institutions relish RRSP season as it almost always coincides with the peak of their annual sales. The salesforce (a.k.a financial representatives) are instructed to go out and sell, promoting the tax savings that clients can achieve – some will even go further and suggest that you borrow and use the tax savings to pay back a portion of the debt. Brilliant for the financial institution since they will profit from the fees on investments PLUS make money on the loan!
To be fair, there may be cases where borrowing to invest may make sense, but those cases are rare. More importantly, this is another example of how financial representatives may be looking out for their own best interest and not yours. If you are contacted by your financial representative in any month of the year besides January or February, that is a good sign, but hopefully any conversation revolves around a complete financial strategy and not just how much you plan to invest.
Any time that you think about making a one-time contribution to your investments, ask yourself the following:
– Would I be better off repaying some debt rather than investing?
– Which account should I use to make my investment?
– What could go wrong if I contribute to my investments?
Very few people have no debt. If you are one of the lucky ones who fall into that category, then please proceed to the next paragraph. As for the rest of us, we must recognize that any investment carries an opportunity cost (i.e. investments could be used to pay down debt, which has a measurable cost). In order to justify making an investment (or for that matter, continuing to hold an existing investment), the benefits of the investment must outweigh the costs of carrying debt. As a simple example consider the following: if you have $5,000 to invest but also have $5,000 or more of credit card debt that charges 18% interest annually, you should only invest if you plan to make at least 18% on your investment (which is unrealistic), otherwise you should pay off the credit card. Adding taxes as a variable into the equation makes it more complicated so we’ll save that discussion for another day.
If you have determined that investing is the correct decision, you must then consider into which account your investment would be most beneficial to you. If you have room in a tax-sheltered account, that will usually be preferable to a taxable account. The default choice for most people when using a tax-sheltered account is the RRSP (usually because that is prompted by their financial representative). The short-term tax refund incentive, and the fact that the RRSP account is normally your largest tax-sheltered account makes it an easy sell. But in many cases, the TFSA account is as good or better than the RRSP for overall wealth accumulation over the long run. Again, this is a topic that deserves far more attention in another post, but in the meantime, if you wish to test it out yourself, there is a free online tool that you can use to run a comparison:
The final consideration is about proactively planning ahead. Determining that you have money available to invest now is a good thing, but what happens if: You lose your job? You want to buy a house? Your child starts university…in another country! You should determine if you might need an exit strategy for your investment, and if so, it could affect the account that you invest in and the type of investment/ product that you purchase. Pulling money out of an RRSP, for example, may force you to pay taxes. Investments like Guaranteed Investment Certificates (GICs) and mutual funds with deferred sales charges (DSCs) have punishing fees for redeeming before maturity so you may wish to avoid these products.
So don’t be persuaded into making that RRSP contribution just before the deadline when your financial representative makes the call. If your financial representative is either unwilling or incapable of providing some guidance on the topics presented here, then it may be time for a new financial representative.
Written by James Gauthier, Chief Investment Officer at Justwealth.