Companion Advisor: Techniques
Finding the money to invest
is sometimes like exercise; we know we should, but we never seem to get
around to it. At least exercise only requires energy and time, both of
which are free. Investing requires the money to start, and finding the
sources of investment dollars is often harder than finding good investments.
Saving 10 - 15 per cent of your gross annual income
is called "paying yourself first". Unfortunately, other demands
like mortgages, cars, and orthodontic braces muscle themselves into the
head of the line. One solution is to make an annual budget of all income
One line of that budget, equaling 15 per cent of gross
family income, is the savings line. This is divided into two parts: annual
RRSP contributions and paying down your after-tax debts such as mortgages
and car loans. First, make the maximum RRSP contributions every year for
you and your spouse. Use your tax refund, and any money left over from
your 15 per cent savings line, to repay after-tax debt such as mortgages,
consumer loans and car loans.
Debt is much more costly that it appears. Since you
have to pay your debts with after-tax dollars you must consider the dollar
amount you actually have to earn before tax to provide the funds to make
the debt repayment. If you are in a 42 per cent tax bracket you only retain
58% of every next dollar you earn. In this case you have to earn $1.72
before tax to have $1.00 after tax. Extending this reasoning to debt interest
rates means that a 10 per cent loan actually costs you over 17 per cent
in pre-tax dollars (10 divided by 58%). Determine your marginal tax rate
and then calculate the actual percentage costs in pre-tax dollars on any
debts that you have. It may encourage you to pay them off faster.
Getting back to paying yourself first , where will that
15 per cent savings come from? From spending less! This usually means
fewer meals out, fewer impulsive purchases, and fewer adult toys such
as VCR's, microwaves, mobile phones, and several dozen other automatic
It will be difficult at first to cut back on expenses,
but every year it will get easier as after-tax debts are paid off and
more money becomes available to spend as you like: not as your creditors
demand. One easy way to "pay yourself first" is to "fool
yourself first". This means having your RRSP contributions and other
investment savings deducted from your bank account monthly. If you don't
see the money, you won't miss it as much.
After your RRSP, your mortgage is the best place to
put your money. Remember, as discussed earlier, depending on your tax
bracket, your mortgage is costing you much more than the stated rate,
in pre-tax dollars. If you have a 10 per cent mortgage, and you are in
a 42 per cent tax bracket your mortgage is actually costing you 17 per
cent of the money you earn before any tax is deducted. This also means
that any investment would have to earn more than the 17% before tax to
be a better alternative than pre-paying a 10% mortgage. Think of every
dollar paid against that mortgage as "earning" you a 17 per
Developing a budget is the best way to make sure you
save for the future while paying off your creditors today. Remember, though,
a budget is a plan, and plans can change. If there are unexpected sources
of income or expenses, don't just abandon your budget in discouragement,
rework your budget to account for them.
There are times when borrowing can be advantageous:
when making RRSP contributions or when the cost of the loan is tax-deductible.
Borrowing to make an annual RRSP contribution, although
not tax deductible, can be a sound idea providing you pay off the loan
prior to the next RRSP contribution deadline in case you have to borrow
again. Use your tax refund to pay down the loan and when it's paid off,
continue making the payments but this time into your RRSP rather than
towards the loan. This way you'll get a head start towards the next contribution
deadline and will be able to reduce the amount you have to borrow at that
If your entire 15 per cent savings line is contributed
to RRSPs and you don't have any debts to pay off, borrowing to invest
outside an RRSP may make sense. Since interest on loans with a purpose
of earning investment income is tax deductible, you will be ahead providing
your investment earns a greater return than the cost of the loan.
Investing, like exercise, is most beneficial when done regularly and sensibly.
Who knows, with good investments, you may get enough exercise just hauling
your money around.
* * *
||Use this link to load a printer-friendly
version of this document.
Have a question regarding this article? Use our feedback form to send us a note.
© , Fiscal Agents Money Management Newsletter
25 Lakeshore Road, Oakville, On L6K 1C6.