Reader Comment: RRSP vs. Mortgage
I’ve run many scenarios of RRSP vs mortgage over the years and have found the main determining factor is a huge surprise.
The top 3 factors in RRSP vs mortgage are:
1. How much of the mortgage payment will be invested once the mortgage is paid off?
2. Investment return vs. mortgage rate.
3. Tax considerations – tax-efficiency of investments and what you do with the RRSP tax refund.
Just ask yourself – once the mortgage is paid off, how much of the mortgage payment will I invest? If your answer is less than 90%, then RRSP is definitely preferable. Most scenarios require 100% of the mortgage payment to be invested before the mortgage strategy can compete with RRSP.
We have found that most people that prefer the RRSP are investors, while most that prefer the mortgage are really anti-debt people. We call this the “Sacred Cow”, which is very common in Canada. The belief is that we should pay off the mortgage and then we can spend much of the money and live a comfortable life without debt.
I often hear people telling me they can retire on almost nothing, since they will have no debt and they won’t be spending much money after they retire. We call this the “Zero Plan” for retirement.
However, when we go through the cash flow in detail and plan specifically what income they will need to have the retirement they want, their delusions are laid bare.
If you believe in the mortgage pay-down, ask yourself if you are really just anti-debt – and whether or not you will invest 100% of the mortgage payment once the mortgage is paid off.
The 2nd most important criteria is the investment return vs the mortgage rate. Considering that mortgage rates are around 5% and should stay low for nearly all of the next few decades (demographic reasons), it is not that hard to beat 5% after tax long term.
If you don’t know how to do this, email me.
Canadian Capitalist is right that the average investor makes returns far below average. In fact, the Dalbar study showed over 20 years, the average investor made only 3.5% while the investments they owned made 11%. How can this be? The human brain is conditioned to consistently market time badly. Read some behavioral finance and you’ll find it is hilarious.
In short, if part of your criteria for buying an investment is that it is currently “doing well”, you will almost definitely earn below average returns.
However, if you study investment philosophy and hire the world’s best investment managers to work for you – and don’t market time – then beating 5% after tax in the long run is a piece of cake.
The long run return of the markets is quite consistently 7% over inflation, based on “Stocks for the Long Run” (first book). There are fund managers that beat the markets over long periods of time – and can tell you why. Invest with a few of them and you’ll be fine.
By the way, a far better strategy is the Smith Manoeuvre. With the SM, you always do both at the same time – pay down the mortgage AND invest. Plus, since the SM requires none of your cash flow, you can still use your extra cash to either pay down the mortgage more – AND invest more, or invest in RRSP’s.
Paying down the mortgage AND investing is better than just paying down the mortgage OR investing, isn’t it?