RRSP or Mortgage: Moneysense Reviewed

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.

Your Personal Time Value of Money

I recently did a calculation of how much money I earn after tax for every minute I work (salary – tax & other deductions + RRSP tax credits) at taxtips.ca to find I earn about $0.37/minute. This little exercise I found very useful to determine how much time I have to work in order to buy something.

For example, a cup of coffee for $1.47 costs me almost 4 minutes (1.47/0.37 = 3.97), and a cookbook on sale for $10.60 costs me about 29 minutes. While a 32 LCD wide screen TV for $1445 costs me about 65 hours (1445/0.37 = 3905 minutes).

So next time you to buy something ask yourself this: am I getting more joy/usefulness out this purchase than it costs me in time to buy it?

So in the case of the cup of coffee if you drink it during a great conversation for 10 minutes, it might be worth the 4 minutes of work. Yet if you drink it while on your way to work for 2 minutes and then let it go cold, it would be a bad deal since you still have to work for 4 minutes for something that gave you less than 2 minutes of happiness (if that long).

The point of the exercise is to check if your really enjoying or using your purchase. If your not really enjoying or using it, why are you even buying it? For example, wasting power with the old 60 W light bulbs seems pointless to me. I need light and the cheaper the better. I don’t enjoy my power bill, so why not buy a CFL that will last at least five times longer and use about 1/6 the power. Yes it costs more up front, but the prices have been dropping and my last set of bulbs cost me about $3 or 8 minutes each for something I will save money with for over five years.

This is just one option, the reality is you need something to slow you down for just a second or two and the question “Am I going to make time (money) or joy off this purchase?”

FAQ

Q: Why do you want to retire at 45?

CD: Why not? No really, the decision to shoot for retiring at 45 was more or less just a date I picked. 55 was too long and 40 was too short, so I picked 45. I want to retire early and the earlier the better.

Q: So where do you dig up all your information?

CD: My information is from a lot of reading of books from the library and a few Google alerts that sweep the Internet daily for general websites, blogs and news sites with information that could be useful.

Q: Do you get paid to do this?

CD: Technically yes. I get money if you click on a link on the site, but the income is so small that I earn more in half an hour in my day job than two months of blogging. So this is largely a labour of love.

Q: How much time do you spend blogging in a week?

CD: So far about 7 hours a week. Usually an hour in the morning during the weekdays a few hours on the weekend.

Q: Do you recommend any stocks or other investment products?

CD: No, I don’t recommend anything. You might even notice in my posts I use the word ‘suggest’ a lot, which implies that you should take everything I say with a grain of salt and do your own research and make your own decision. After all you are an adult and I don’t have to tell you what to do.