Financial Uproar

My Canadian is showing again, AND I REFUSE TO COVER IT UP. If you’re an American, this post may not apply to you. I apologize for nothing. Move to Canada. Sure, it’s colder here, but the ladies are hotter and the health care is FREE BABY!

So, let’s assume you were kind of a slacker this year and didn’t bother saving much of anything to use to contribute to your RRSP. You spent the money on strippers and cocaine, and then wasted the rest. Because you’ve heard all about how you should be saving for retirement, you want to contribute, but have the small problem of not having any cash. What’s a poor fella to do? How about an RRSP loan?

RRSP loans are available at your local financial institution at prime +1-2%. (meaning you’d pay 4-5% for one today, depending on your credit worthiness) They can be set up as either a line of credit or a straightforward loan, and I’m sure the bank issuing it will let you take a few years to pay it off if you so choose.

At first glance, they seem like a bad idea. Why not just set aside a few hundred bucks a month to contribute to your RRSP? Better yet, if your employer offers any sort of RRSP match, you should be taking advantage of that right now and than thank them profusely for the free money. And yes, I agree. Ideally you should be contributing every month, or even in one lump sum payment on February 28th because you procrastinated all year. (This may or may not have happened to me)

But what about if you’re just starting on your financial journey?

Let’s assume somebody is in the 40% tax bracket, just for easy figuring. They take out a $5000 RRSP loan at 4%, doing it in February, since they know their income tax refund will be coming back in March. To keep things simple, let’s assume our imaginary person paid exactly enough tax, meaning their entire refund will be because of their RRSP contribution.

If the entire tax refund is put towards the RRSP loan, that means the amount owing is $3000 after just a month. $300 per month takes care of the rest of the loan in 11 months. At a 4% interest rate, a paltry $46 is paid in interest. You paid $46 to access $5000. That is a ridiculously low cost to pay.

There’s a couple caveats. If you don’t use that tax refund to pay down the loan, you obviously shouldn’t bother. And, secondly, if you have to repeat this process every single year, you probably need to work on your savings skills. This strategy is designed for someone just starting out, someone with little debt so they can afford the payments.

Most of the time, someone using this strategy will be getting a larger tax refund than just the one created by contributing to the RRSP. If our imaginary person from above was getting an additional $1000 in a tax refund before contributing to the RRSP, they could pay off that loan in just 7 months, meaning they’d have 5 more months to put that money towards next year’s RRSP contribution.

Naysayers will point out the flaws in recommending someone go into debt. People are morons they’ll argue, why would you recommend they go into debt? Well, I believe that debt used to buy assets is generally good debt, assuming people are smart and pay it off in a reasonable amount of time. Many people abuse debt and it gets them into trouble. There are all sorts of other people who use debt to their advantage. You’d have to be a special kind of moron to borrow to invest in an RRSP if you have credit card debt.

This strategy isn’t for the faint of heart either. By borrowing to contribute, you’re using leverage, which automatically makes any investment more risky. Imagine borrowing $5000 and investing it in the stock market, only to have the market fall 10%. Your $5000 has dropped in value to $4500, and you might not have paid a dime back. If that type of situation makes you all queasy, you probably shouldn’t borrow to invest in general.

And, of course, the higher interest rates get, the less appealing this strategy becomes. If you double the rate, you double the cost of borrowing. (That may have been the most obvious sentence I’ve ever written) At what interest rate does the cost of borrowing become too much?

I actually think borrowing to invest in an RRSP isn’t such a bad idea, providing the borrower pays the damn thing off quickly and doesn’t blow their tax refund on video games and Fanta. Now you can disagree with me in the comments.

My grandparents own a golf course.

When I was a kid, I thought this was the coolest thing ever. I would spend almost entire summers out there. While there, I’d spend easily 8 hours a day golfing. Being the owners’ grandson meant I could sneak on the course whenever I wanted, getting in a quick 9 holes whenever there was an opening. I also served as a distraction for my Grandpa, he’d take time to stop working to golf with me. Grandma would make me all sorts of good stuff, my favorite being cheeseburgers. Some of my favorite childhood memories are from my time spent on the golf course, including the time I got a hole in one.

My Grandpa is over 80 now. My Grandma hasn’t been involved in the day to day operations of the golf course for more than 10 years. They’re both old and are starting to inevitably slow, both mentally and physically. Both have had heart problems over the past year. Grandpa has realized he can’t work anymore, so he’s started the process of selling the golf course.

As you can imagine, selling a golf course is much more difficult than selling a house. There aren’t many people who have both the means and desire to buy one. There is a mountain of paperwork that is needed for any prospective buyer. Grandpa is a little slow these days, so getting the proper paperwork in order takes a little while. I’m not too involved in the process, but I can imagine it’s beginning to turn into a nightmare.

I know a guy who is turning 72 this year. He is quite wealthy, I’d estimate his net worth to be over $2M. He owns quite a few rental properties, as well as a good chunk of change in the stock market. Since he’s in his 70s, one would think he’s going to start slowing down and selling his rentals soon, putting the proceeds in something safe and boring.

He has no intention of selling a single property anytime soon. In fact, he just bought another one.

This Can’t End Well

My Grandparents and my friend are both going to experience some pain before things get worked out. Both are wealthy enough from other investments to ensure they have enough to live on while they wait for assets to sell. Even though they’re not screwed financially (unlike the Wal-Mart greeter Leonard) they still haven’t put themselves in a good financial spot.

All my Grandparents want is to get rid of the burden of this business. They want the money from the sale to ensure that they’ll have enough to comfortably survive for their last years here, as well as leave an inheritance to their children. I’m not sure if they’d ever admit it (my Grandpa definitely wouldn’t) but the prudent plan would have been to sell it 5 years ago when both were healthy and still active.

My early 70s friend isn’t in that same boat, but he could be soon. Health is a fickle thing, especially as you get older. My Grandpa went from working to in a hospital bed in about a day. I’m sure all of you can tell me similar stories about your relatives. We never know when our health is going to fail on us.

One day, my friend will fall ill. Perhaps he’ll die, hopefully he’ll live. In either situation, he’ll be sitting on all sorts of illiquid assets that someone will have to sell. This is not an ideal situation for someone who already has the stress of being sick on their plate.

Proper Planning Is Key

It isn’t really that hard to avoid being in the shoes of my Grandparents and friend.

Once someone gets to the point of thinking about retirement, then it’s time to move your investments into safe, liquid instruments. Things like government bonds and boring stocks like utilities should be purchased for a portfolio. GICs (or CDs) deserve a place in a portfolio as well. Capital preservation should be key.

Yes, these investments won’t grow much. The whole basket will barely out perform inflation. As you already know though, retirement isn’t the time to take risks with your investments. All it takes is a little planning to avoid being stuck with illiquid assets.

One look around and it’s easy for me to see the results poor planning can have on a family. My family is having to deal with selling an asset that should have been sold years ago. My Grandparents are stressed out about it, which makes their kids stressed out. Their inability to plan properly is affecting everyone around them.

Why This Matters At Any Age

I don’t care if you’re 18 or 80, liquidity matters.

Most financial type people solve this problem with an emergency fund. And even though I somewhat disagree with someone keeping large amounts of cash on hand, I always maintain a balance in my chequing account of $10k. The security of liquidity is important to me.

Alternatively, someone can use a line of credit or credit cards for an emergency fund, PROVIDING they have the cash somewhat easily accessible to pay the loan back without paying much in interest. If you’re the kind of person who feels the need to earn interest all the time, I have no problem keeping your emergency fund cash in good conservative bond funds. This money is accessible enough that you can have it in a few days, giving you plenty of time to pay off a credit card or line of credit with a minimum interest penalty.

Whichever way you choose to treat your emergency fund, just remember the importance of liquidity. Having illiquid assets is fine when you’re young, but please encourage your parents or grandparents to keep them to a minimum.