Record Tax Refund

We just did some preliminary tax calculations and thanks to carried-over tuition/education amounts from previous years, and our RRSP contributions from last year, we will be getting a tax refund of around $9500. Sorry you can’t “act now to receive my amazing tax secrets.” We just had a lot of tuition credits to use, but we have now used up all our tuition/education amounts so that will be the last time we have that kind of a refund. We will either be putting that refund into our RRSPs, then reducing our monthly RRSP contributions over the next 12 months, thereby increasing the amount we can put down our student line of credit each month, OR putting it down on the line of credit thus reducing the amount of interest we have to pay on the loan each month, thereby increasing the amount of principal paid each month. Either way, it doesn’t really matter too much. I figure the risk-adjusted return on the RRSP compared to the line of credit is about the same. Although the student line of credit is at prime so the return there is really low.

Don’t Squander Your Tax Refund

A reader that goes by “David” provided a link to an article from AIM called “RRSPs versus non-registered accounts.” Here I quote part of his comment:

There are opinions all over the place on these calculations. A study published by AIM Trimark states that RRSP only come out ahead if the refund is also invested. IF the refund is used for other purposes then the un-registered investment is a better choice. RRSP vs. Non-Registered.pdf. This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).

This was my reply:

David, thanks for AIM link. Totally makes sense and thanks for bringing up the fact that the refund must be invested, not squandered. This is implicit in Martin Gale’s calculation, as you pointed out “This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).”

I am writing this blog post just to emphasize this point again. The reinvestment of the RRSP refund was implicit in Martin Gale’s calculations and I sort of missed it the first time I read the article. I understood how he used $1000 in the RRSP and $640 outside (pre-tax and post-tax amounts respectively) but hadn’t fully realized the significance. Remember that you are deferring your income tax until later. The government gives you back some tax that it collected throughout the year but you’ll need that for later, when you withdraw from your RRSP and have to declare it as income. So you better invest the tax you saved now to offset those income taxes you’ll be paying later. As “David” above pointed out, IF the refund is used for other purposes, like a new TV, then the unregistered plan is a better choice. And when we say better choice, we mean a better choice for the long term… but if you get a new TV now, that’s better for the short term (well, if you think TVs are a good thing). Like Jerry Seinfeld said when comparing medicines at the pharmacy “do I want to feel good now, or later?” I think it’s best to try to find a good balance of both.

I have written a lot of old articles having to do with putting your tax refund to good use, so I won’t belabour this point and further.

Financial Lessons Learned Through Parents

Canadian Dream had a post called “Parents Influence Over Their Kid’s Money.” Part of it reminded me of my own experience:

The other thing my parents did for me that really hit home was during my second year of university they stopped paying the bills. They had decided to buy a cottage instead of funding the remainder of my education. So they co-signed some loans and I was now living off debt to pay my school. I hated it, but it taught me to pay attention to my spending. Needless to say I reduced my spending at school by 10% the next year and I started paying down the debt with every dollar I could after leaving school.

This reminded me of a similar event in my life. My parents had bought some Canada Savings Bonds for me when I was a kid, as a college fund for me so I would not have to worry about paying for university. When I was maybe 12 my parents wanted to buy a cabin at a nearby lake as an investment/rental property. In order to afford the down payment, they cashed in those Canada Savings Bonds. So when I went to university, I was on my own. It turned out I had a scholarship anyways that covered most of my tuition but I had to pay for everything else. My parents bought me a $2000 used car right at the beginning of university and besides that I was on my own for any vacations I wanted to take during my summers, any “toys” I bought, gas, car insurance, textbooks, and everything else. So I worked part-time through most of university so I could pay for everything and have some money left over for long-term savings as well. So my situation was not the same as most as I had no debt. It wasn’t a case of either my parents supporting me or going into debt. It was a case of finishing university with only a little money leftover vs. having a lot more leftover or spending more, and not having to work (had they had not cashed in those bonds to buy a rental property, but instead given them to me). There is no guarantee that they would have given me those bonds. I had a scholarship so I didn’t really need them, but you never know. They had earmarked those bonds for my time in university so it might have gone to me in some way, maybe it would have gone toward an unnecessarily larger car, a more expensive vacation than the cheap ones I did (mostly camping), or toward my other expenses, meaning I would not have had to work. In hindsight I was so glad that after high school I was basically on my own. I worked hard at my part-time job as a grocery store clerk on weekends, tutoring in math, and my job at a local movie theatre and learned that the only way to make money is through hard work. Like “canadian dream” above, “it taught me to pay attention to my spending.” It is best to learn those simple lessons as early as possible.

While I was in high school I was always a little bit annoyed at my parents for cashing in those savings bonds. I had heard about other people having a “college fund” and I was annoyed that I didn’t have one, or rather, at the fact that they cashed them in for a cabin we rented out and never used. But later on I realized that not having a college fund is one of the best things they did for me. Cutting me off from their finances early on was great as it allowed me to become financially independent and to learn how to look after my money. It forced me to make more mistakes early on, mistakes that I learned from. More recently, over the past few years my wife’s parents have mentioned that they want to help pay down my wife’s line of credit leftover from school. We have been refusing their offers of help because we think that paying down this massive debt on our will be a great experience, like preparation for having a mortgage or a car loan (actually this line of credit debt makes me NOT want to ever have a car loan). We have done an excellent job so far at maximizing our RRSPs, while at the same time paying down our debt as much as possible. In order to do that we have had to limit our expenses in some areas, live in a place that is a bit smaller than we would have lived in otherwise, and live without that fat wad of cash that is currently getting sucked away to interest every month. But we’ve already learned a huge lesson, about the burden and cost of debt, and we’ve figured out what our priorities are as far as expenses go.

So, what did you parents, guardians, or other do financially to you that you didn’t like at the time, but that in hindsight, now seems like a blessing?

US Dollar vs. Canadian Dollar Investments Inside RRSP?

I am going to be buying a US ETF (like an S&P 500 ETF) and an international ETF (like an MSCI EAFE ETF) in the near future in my or my wife’s E*Trade self-directed RRSP account. I was just wondering if anyone out there has some good advice on whether I should buy the US dollar ETFs, like VTI (Vanguard Total Market) or EFA (iShares ISHARES MSCI EAFE ETF), or the Canadian-dollar hedged versions, like XSP (iShares S&P 500 ETF) and XIN (iShares MSCI EAFE ETF). Currently I have no USD investments.

Here’s the advice I have to go on so far. This might be of interest to others who are asking the same questions.

  • Martin Gale seems to recommended the Vanguard funds (which are all in USD-only and traded on US exchanges) because of their low MERs. He reminds readers to “please think about where you will be when you spend your investment savings. If you are planning to live in Canada then your expenses will be paid in Canadian dollars. In that case it would be worthwhile making sure a lot of your investments are in Canadian dollars as well–perhaps by concentrating on Canadian bonds.”
  • In another article by Martin Gale about the scrapping of Foreign Content rules in RRSPs, he has a long section called “Thinking About Currency.” The key message here seems to be balance. Some currency risk (ie. having some holdings in USD) is ok but make sure a significant portion of your savings is in Canadian dollars. He throws around 40% CAD in your nest egg for young people and 80% for more conservative investors, saying that “That should provide adequate protection from the whims of the swinging Loonie while still ensuring a proper global allocation.” On the other hand, too much investment in Canadian dollars is also bad thing. In another article entitled “How much US dollar investment in your RRSP is too much?” he says that “If you still have many income earning years ahead of you, but your job prospects depend on the Canadian economy (most working people’s do) then you might want to avoid Canadian investments lest your job and your savings are both lost in the same Canadian recession.”
  • The Canadian Capitalist has mentioned USD currency exposure a lot in the past and in fact just re-iterated his opinion on it today, “I believe that investors with a reasonably long-term view (more than 10 years) should ignore currency fluctuations, as it is impossible to precisely predict currency movements even in the near-term.” In other words, I think what he’s saying is that the currency fluctuations will help you some years and hurt you in others but over the long term your return in CAD will probably be fairly close to the return in USD. A while back he talked about the difference between iShares and iUnits (the Canadian ones, now also called iShares). He later said he would have used the USD versions rather than the CAD versions if he were to start the Sleepy Portfolio all over.

I am leaning towards going with the USD versions since I have no US currency exposure, and to avoid the extra cost associated with the currency hedging on ETFs like XSP and XIN. Also, as Martin Gale said, the Vanguard ETFs are very low-cost, and there is more variety, compared to what we have available in Canada.

The Case for RRSPs Over Everything Else

Martin Gale form Efficient Market Canada just wrote an amazing piece, laying out the case for RRSPs over non-registered investment in a growth stock, a dividend stock, and a mortgage payment. This article is a MUST READ for anyone who has every wondered if investing outside an RRSP has some advantages over investing inside an RRSP. Or if you have ever wondered if you should pay down your mortgage rather than investing in an RRSP. Here’s the set-up:

Are people really better off saving money outside of an RRSP? Some say buying and holding growth stocks that pay no dividends is another way to defer taxes, and that investments in an RRSP lose access to the dividend tax credit. Others say that it’s better to repay your mortgage than invest in an RRSP There are a lot of people out there who say things like this and they are almost always wrong. The arguments for non-registered investments generally involve a lot of handwaving and grand claims so let’s break it down and look at the numbers. First we’ll look at buying stocks in and out of an RRSP, then we’ll compare an RRSP to a mortgage payment.

This article is going to be a straight-forward proof that investments in an RRSP beat investments outside of an RRSP in terms of expected returns.

A couple notes about his calculations… As he says, “Note that if anything these assumptions bias against the RRSP because for many people the tax on withdrawals from an RRSP will be lower in retirement than the tax saved at contribution time.” He goes on to give a good reason for why this is usually the case. Another reason these calculations are biased against the RRSP is because he neglects the fact that the investments outside the RRSP might be taxed every year if you are selling your investments every year and buying new ones, for example, whereas inside the RRSP your investments will experience tax-free growth. I just did a quick back of the envelope calculation and this does make a difference.

In the end the RRSP wins out in each case, even though some simplifications in the calculations bias the calculations against RRSPs. The key reason the RRSP comes out ahead, as he explains so well, is because of double taxation outside the RRSP. Taxation on your income (off your paycheque), then taxation on the gains made off those investmentes. In the RRSP you are only taxed once, when you withdraw the entire thing, your gross income plus gains from the RRSP as income.

Almost everyone who argues that the non-RRSP is better ignores the fact that the non-RRSP payment was made with after tax dollars, in other words, they ignore the double taxation.

Around this same time last year I looked at a Phillips, Hagar, & North report that compared investing in an RRSP with investing outside an RRSP. It was called “The Retirement Savings Debate: Inside or outside the RRSP structure” and their conclusion was that

saving for retirement using a registered plan (RRSP) is more beneficial than saving in a non-registered, taxable account. There are a few exceptions to this, but for the most part, this conclusion will hold true for the majority of middle- and upper-income earners.

If anyone finds that PH&N report, let me know. That blog post also had a quote from Derek Foster, which after looking at it again, now seems like total bunk.

I also wrote about paying down student loans vs. contributing to an RRSP although I neglected a few things (see comments).

Family Housing Story From 1982

I just had an interesting conversation with my dad a while back about the housing bust of 1981. They bought their house in 1977 for about $40,000 with a $471 monthly mortgage payment for a 25 year mortgage (Those numbers don’t work out quite right for an interest rate of approximately 10% at the time, but it doesn’t matter). They somehow also managed to put down 10% of the house’s original value every year (I think their tax rebate due to RRSPs may have helped out here), so in 1981 when the crash hit they were ok. When they went to renew their mortgage in 1982, they were quoted a 18.5% interest rate (just shy of the 20% peak). They didn’t have that much left on their mortgage after paying down 10% of the principal every year for the past 5 years, so they went to my grandfather (my dad’s father) for a loan. He loaned them about $10,000 at 14.5%. He was definitely not gouging them though; this was worse than the 19% he could get on Canada Savings Bonds at the time. They then took out a line of credit and paid the rest of the mortgage off using that. That was supposedly done to simplify the repayment terms (no longer stuck with a mortgage, can switch between loan-from-dad and line of credit more easily, and can pay down more principal whenever they wanted).

I don’t really have anything insightful to say there. Just that it’s an interesting story. The only thing I will bring up though is that I think everyone should consider the possibility of borrowing from a family member, or lending to a family member. You should be careful and think about that negative consequences if the borrower was unable to pay back the loan or make their payments. My parents payed back the loan to my grandpa, and then when they bought a rental property in the 1990s as an investment they borrowed money from my grandpa again. So it worked out well for them.

Things You’ll Never Hear Me Blog About

A lot of investing and personal finance blogs talk about certain topics that I purposefully stay clear from because I really don’t like them and am not interested in them. I often remove blogs from my blogroll if I notice they talk about these things too much.

  • 0% balance transfers and the like. Seriously, what is up with this craze?
  • Kiyosaki or Cramer (at least, in a positive way).
  • Rewards programs. Not a fan. I finally got rid of my Air Miles card and went to the cashback option for our one credit card. I hate points programs, customer loyalty programs, or anything of the sort.
  • Trading, daily stock prices, etc… I focus on the long term. I couldn’t even tell you right now what the trend in the markets has been in the past month. I don’t follow the market.
  • Promotions. Promotions serve only one purpose, to get new customers. Their purpose is not for you to make $15 or whatever it might be.
  • Talking about how to make money blogging, or how much money I made from ads last month, etc… This blog will never be a for-profit operation. Never take advice from a blogger who is trying to blog for a living (or most journalists). How do you know if his/her advice is really coming from the heart if she is getting a kickback every time they right a post? To prove I don’t blog for bucks, download AdBlock Plus for Firefox and please block my ads (I do). Then tell your friends. The only reason I have ads is to cover hosting costs.

So if you are interested in reading a blog that swears to steer clear of the above topics, you have come to the right place.

On the topic of annoying things, I have been receiving an incessant amount of offers these days via email for link sharing, collaborations, requests to demo debt consolidation software, and a number of emails that start out like this one did: “My name is XXX XXX, I recently came upon your blog. I read a few entries and liked it. I work in the financial services industry and as a side project my company has…” Delete!

12-Year Old Financial Blogger

You gotta see this. There is a 12-year kid giving financial advice on his blog

Some of his advice is questionable, like this one:

“Ya, hi, I’m over 150,000 in debt, not including my mortgage. I’m fearing that I’ll have to give up my lifestyle and everything I own. Is there anything I can do?” Well, I do have one piece of very good advice, find a really tall building… No, I’m just kidding! but seriously, the one thing you can do to take evasive action on that kind of debt is to, hold your applause, go further into debt! Ya, as crazy as it sounds, if you go another 300,000 dollars in debt and buy a condo, you can rent it out and slowly pay of that debt, plus the mortgage with the rent. And once you’re almost out of your financial rut, you can sell the condo for a profit and be completely debt free!

That seems like a sure-fire way to make your situation worse rather than better. Especially in today’s housing market. The guy is $150,000 in debt, plus he has a mortgage (let’s say $200,000 left), and he’s suggesting to take on another $300,000 in debt (if you can get approved for that, which is doubtful with the debt load he/she already has). Good luck trying to rent that condo for enough to make up for the mortgage (let alone having extra to apply against the $150,000 debt). And good luck selling the condo for a profit if housing prices tank (which they will).

He sort of explains himself in his next post, but there are still some assumptions I don’t like, like the one where the second house grows from $400,000 to $500,000 (timeframe not given).

Either way, this kid is one smart cookie and I’ll be keeping my eye on him.

Some RRSP Myths

In the Globe & Mail, Dale Jackson Debunks some RRSP Myths. Overall, I thought the article was good and I liked it.

In debunking Myth #2 in the article, Dale Jackson says “There’s also a strong argument for young investors to delay making RRSP contributions until they are in their higher income years and the tax savings are bigger. The trade off would be less time to allow savings to grow tax-free. [emphasis mine]” First of all, he is confusing himself and all of us when he misuses the term “contributions” with “deductions.” He means to say “deductions” here. Let me re-write his quote the way I think it should be: “There’s also an argument for young investors to delay making RRSP deductions until they are in their higher income years and the tax savings are bigger.” I have replaced “there is a strong argument” with “there is an argument.” In a previous blog post I did some calculations to determine whether or not it is smarter to delay that RRSP contribution or not. As far as contributions go, there is a strong argument to make contributions right away without delaying, so you can take advantage of tax-free growth. ie. no capital gains and no tax on dividends or interest.

Another small detail concerning contributions and deductions. Myth #3 is: “3. You must take advantage of your maximum allowable contribution the year it is issued.” Answer: “Wrong. The difference between the allowable amount and what you contribute can be used in later years.” Although this is totally correct, you could also write a Myth #3.5 (which I think is a WAY, WAY, WAY bigger myth): “3.5. You must deduct all of your contribution the year you contributed.” Answer: “Wrong. The difference between what you contributed and what you have deducted (which is 0 if you haven’t made any deductions) can be used in later years.” Essentially, you can contribute to an RRSP when you are 16 and make the deduction when you start working full-time after university at the age of 22. That’s 6 years of tax-free compounding. Seriously, I don’t think I’ve met anyone who knew that you could contribute to an RRSP and then deduct it later. I don’t blame anyone though because it’s just not a common thing to do once you get older.

There were actually some pretty good comments in the comments section. I recommend checking it out. There are also some not-so-awesome comments but other readers are quick to point out the flaws.

One reader, Gardiner Westbound, says “. . . Modest income seniors approaching retirement should cash out RRSPs before applying for OAP, GIS and other benefits.”

Nick B. quips:

Gardiner, way to go dispensing unqualified financial advice. An individual applying for those benefits in short order should be working with their bank or advisor to determine how their finances are going to look. There may be a need to manage RSP withdrawals to create non-registered savings, but simply cashing out may well not be a good decision . . .