Your Investment Objectives
Posted by Gail | Filed under Investing
People invest for one reason: to make more money. But what are you making more money for? If you’re looking at retirement 20, 30 or 40 years down the road, that’s very different than trying to make more money to buy a house, put your kids through school, or go on a much longed for family trip.
A while back I wrote about thinking of your money in four piles: cash flow, emergency, planned spending and long-term saving. It might also be useful to break your investment objectives down – and your investment dollars into separate pools — to better see what it is you’re trying to accomplish. Pools could better help you match the right types of investments with your goals, keeping in mind your risk tolerance and time horizon.
Here’s an example of what I mean. There was a time when the only thing an RRSP was used for was retirement planning. “Never touch this money,” the experts expounded. “An RRSP is a long-term investment,” the specialists declared.
In reality, people use their RRSPs for a multitude of purposes. Some people dip in when they quit their jobs to return to school or train for a new career. Couples with families dip in to provide income while one or the other is at home with their tots. People thrown into periods of unemployment because of declines in business and layoffs dip in to make ends meet. Even the government got into the swing, introducing two perfectly legal ways to dip in without tax consequence: to buy a home or to fund your education.
For each pool of money you create for investment, whether inside or outside an RRSP, you must know your purpose – your final goal – before you try to decide what investment vehicles to opt for. If in fact you have a long-term investment horizon – you’re not planning to use the money until you metamorphose, and you’re a mere caterpillar now – you’ll be fine buying stocks and equity-based mutual funds. But if you’re using your savings pool to build a cocoon in another two to three years, you don’t have a long-term investment horizon. It doesn’t matter that you’re using an RRSP as your savings vehicle. If you’re planning to pull some or all the money out for a downpayment, you have a short-term horizon and shouldn’t be in equities.
No matter how long-term your home ownership plan starts off as, at some point before you go house hunting you have to adjust to a medium and then a short-term investment horizon. That means moving from alternatives like stocks to medium-term bonds, then short-term deposits and, eventually, cash.
One of the toughest parts of managing an investment portfolio is keeping track of what money is for which purpose, so you can continue to adjust your asset mix as your time horizons change. Whether you pool all the money together in a single investment plan, or you keep the pools separate, it’s a good idea to put a timeline on the front of your file folder as a reminder about remixing your assets as your time horizon shortens. So if you’re planning to lay some eggs six or seven years down the road, you might remix your portfolio at the five-year mark, and again at the three year mark. A good advisor can help you do this, but you must be up-front about how you plan to use the money.
Finally, while it’s fine to use your investment dollars for any purpose you wish — it’s your money, you get to decide how to spend it — it’s important not to sacrifice your long-term goals for your short-term dreams. If you’re saving for a home, instead of putting your whole RRSP contribution into your “Home ownership RRSP” this year, divide it equally between home ownership and retirement. Yes, it will take a little longer to get into your dream home. But when you do, you won’t be behind the eight ball in terms of retirement planning. Striking the right balance in saving is just as important as in life. A little into each pot will serve you well.
I’ve had quite a few requests recently for sample Budget Binder pages. This is an example of something that already exists on the site and you just have to search for it.
February 18, 2009 at 9:08 am
a new book?!! how exciting!
February 18, 2009 at 11:30 am
I could never understand why anyone would borrow from their RRSP to purchase a home. How can they possibly afford to pay back their RRSP when the time comes? If you can’t afford to save for your down payment, how can you afford to pay back your RRSP after you have purchased your home? After you have purchased, there are so many unexpected expenses that crop up. Has this ever worked for anyone?
February 18, 2009 at 11:44 am
When you use the HBP to borrow interest free from your RRSP to buy a home, you basically pay back $1500 per year until you’ve paid it back. It worked well for me, since it’s a $20k interest free loan. At 6 percent on your mortgage, the interest alone would be almost the amount of the yearly principal repayment.
February 18, 2009 at 11:45 am
Diana C,
Your home ownership RRSP repayment happens over 15 years and we have ours taken off at tax time – for the $11,000 we pulled out of RRSPs for our downpayment, we pay less than $800 a year and usually paid off by our tax return. It has worked for us.
February 18, 2009 at 11:59 am
With the HBP you have a 2 year grace period and then 15 years to “pay yourself” back. Your yearly pay back amount is whatever you borrowed divided by 15 years. Mine is $500.00 per year. However, you take this amount out of your annual RRSP contribution. Mine is at a min of $4000 a year so on my taxes I allot $500 to my HBP plan but I have actually deposited $4000 into my RRSP account but only get $3500.00 credit on my taxes.
It is not in your best interest to “pay it all back at once” as you would then not have any tax benefits. ie; I allot $4000 to my HBP and only have $3500.00 left to pay back but didn’t get any tax credit in that given year.
The less you pay back the more you can use against your taxes with the amount that you would already be inputting into your RRSP account. The RRSP contribution is still the same and in the same “bucket” its just how you direct it in the case of paying back your HBP. Ideally, if you had the additional funds you could deposit the HBP amount and still have your full RRSP contribution to apply to your taxes.
However, in hindsight, I wish that we had found Gail 9 years ago and had a 20% downpayment to avoid CMHC fees.
February 18, 2009 at 12:09 pm
Thanks for everyone’s replies. It now makes sense to me! This is such a wonderful forum.
February 18, 2009 at 12:23 pm
To Jay:
Not everyone pays back $1500 back a year. It is actually dependent on how much you take out of your RRSP for HBP (Home Buyers Plan) or LLL (Life Long Learning). People should keep in mind that you can pay back more than your designated amount for any given year, provided you have room within your RRSP limit. If you fail to pay the amount back (put into your RRSP), any outstanding amount is added at tax time to your income.
February 18, 2009 at 12:26 pm
Here is how some people increase their downpayment using the HBP.
Make a BIG eligible RSP contribution before the March 1st deadline. Get a big tax return. Use BOTH the big tax return and the HBP withdrawal for the downpayment. If you contributed $20000 last minute, you might have $26000 for your down (depends on tax bracket). You repay the $20000 over the 15 year rule.
Drawbacks: potential return on an investment of $20000 over the 17-year period and finding the money to repay the HBP. This requires discipline!
You can pay it back faster if you wish ON TOP of your regular RRSP contributions. Joanne picked a method that works for her.
I don’t like the HBP because new homeowners have too many surprises and they often tend to have babies not long after buying a house.
There are requirements to fulfill in order to qualify for the HBP, so read CAREFULLY before choosing this road.
February 18, 2009 at 12:50 pm
Marie — the drawbacks can be mitigated. You can hold cash in an rrsp account (in a money market fund) so there’s no drawback at all viz. potential return (aside from minor loss of interest income over the 90 day minimum holding period). And unlike many loans, you don’t technically have to pay the HBP back, but if you don’t what your annual contribution should have been is added onto your taxable income. So if you have lots of cash but no rrsp, it makes more sense to dump that money into your rrsp, wait 90 days, get your return, cash it out per the hbp, and use your refund and original contribution for downpayment (and you don’t need to put your refund into the downpayment, you can use that to pay for the baby!). Just made $20K turn into 26K-ish. And even though you are ‘paying back’ your rrsp, the repayments are still building up your portfolio.
February 18, 2009 at 2:38 pm
@Cynthia – yes, you’re correct… I probably oversimplified, just going with the (then) max HPB withdrawal situation. Personally, I ended up taking less, and my repayments are about $1300/year.
February 18, 2009 at 2:38 pm
Plus, if you are only borrowing $20,000 or so, it’s pretty reasonable to pay that back within 17 years. After all, I think Gail recommends putting aside $100 a month to RRSPs, so you’d only be following that minimum, or even less. And like Geoff says, if you absolutely can’t pay it back, the worst thing that happens is that you have that amount added back to taxable income – still better than having to pay premiums or paying extra interest due to a smaller down payment.
February 18, 2009 at 4:43 pm
Diana C…
Yes, this worked for us also. We didnt have a downpayment saved due to a few circumstances, one being that I was in school at the time. We pulled some RRSP’s under the HBP, bought our home. I graduated as a Nurse just a month after we purchased our home. Of course, now having both mine and my hubby’s income, repaying on our HBP is miniscule. I can understand your way of thinking though….I would agree to those thoughts myself….but from experience, I now know that it can work.
February 18, 2009 at 4:44 pm
It’s actually really funny that Gail should post this today. My Mom & I were just trying to figure this all out last night. I am a recently graduated university student in my first full time job we were trying to figure out the best amount for me to put into an RRSP to get the maximum benefit. I have decided to put in more than I was orignally going to because of the HBP. It seems like a great idea!
February 18, 2009 at 4:58 pm
DB — just be sure to adjust your horizons accordingly. It really is a good program but like a credit card can be abused/not work out well (ie anyone investing in the past year but unwisely planning to withdraw it for the HBP this year now has 25% less of a downpayment). An RRSP can have gic’s, cash, bonds, etc just as easily as equities (stocks). I kind of liked a hidden aspect of saving for a house or loft in my case, as the money really wasn’t accessible and I lacked discipline when I was younger. I mean it wasn’t inaccessible like an ING account which takes a few days for an electronic transfer, it was inaccessible as in I’d have to fill out forms, get them signed off on, meet with people, etc and I wasn’t going to do that for a playstation 1 (yes I’m old I know).
February 18, 2009 at 5:51 pm
More than exciting. We’ve read enough of Gail’s stuff and seen enough of her shows to know that they will worthwhile materiel. Hey Gail, how much will it cost me to get the first copy? Do you want the money now?
February 18, 2009 at 7:15 pm
We haven’t come anywhere close to maxing out our RRSP contributions EVER. I feel good that we are saving something every month but stressed that it won’t be enough. How much should we sacrifice from today to secure and uncertain future?
That’s what keeps me up at night.
Not debt ’cause I don’t have any to speak of.
Not my mortgage ’cause it’s safely managable.
Not my kids’ education ’cause I am sure they will follow their dreams whether I help of not.
It’s my old age that I’m worried about. So far away, but not THAT far!
February 18, 2009 at 7:26 pm
We took our down payment and filtered it through our RRSP’s. It sat there for 61 days then we pulled it out and purchased. For us, having just been out of school and working at paying off loans/credit cards/cars first (the bank made us eliminate all debt but our small LOC prior to mortgage approval last year.) We borrowed 20k from our parents for half the down payment and will be able to pay half that off this year when we get our tax returns, the other half will come from the $800 per month we’ve been saving up through having a roommate. By August we’ll only owe our mortgage and RRSP, debts we would have had anyway. The difference the government will enforce our RRSP deficit. The FHBP is a great tool if you can use it like we did.
February 19, 2009 at 12:41 am
I also talk to people about viewing the RRSP as a “make less money” plan. I teach for the self employment assistance program funded by EI and I tell the class at this time of year, they should beg or borrow as much as they can and put it into RRSPs. Most of them worked most of 2008 and will be on EI for 2009 plus any money they make from their business so most likely they will be in a lower tax bracket in 2009. So put the money in when you are in a higher bracket (2008) and take it out in a lower bracket (in 2009). And if their business does well and they don’t need the money, they are fine. Another example I just did with someone was to have her husband max out his contributions to a spousal plan. He makes $125,000 so the deduction is quite significant. After 3 years the plan is vested to the wife and she can take it out while on parental leave and she will have a minimal tax hit. And another thing people miss is that even someone who is over 70 can continue to contribute to a spousal plan as long as his spouse is under 70. This is a way for people to use up their unused room especially if the younger spouse doesn’t have much room. The only drawback of using the RRSP as this type of tool is that unlike the new TFSA, you don’t get the contribution room back when you take the funds out.