Should You Borrow To Invest?

It is RRSP deadline time. You have until March 1st to make a contribution for the Tax year of 2017. The maximum contribution that you can make is 18% of your 2016 earned income, up to a maximum of $26,010 (less any pension adjustment).

A common question around this time of year is: "should I borrow to max out my RRSP"?

And my simple and yet rather complicated answer is:

It depends!

If you go to this link: Tax Calculator, you can figure out what your tax savings will be for your income and contribution level.

Then you have to factor in the cost of borrowing.

Lets just say that you borrow $20,000 at 5%, that is going to cost you $1,000 in interest over the course of the year. That interest is not tax deductible.

According to the tax calculator (above), if your income for 2017 is $100,000, your tax savings (if you reside in Ontario) would be $7,622.

Here is the catch: at some point in the future, you are going to have to pay income tax on the $20,000 when you withdraw it from your RRSP (or perhaps your RRIF if you take it out after you turn 72).

We all have no idea what our income tax rates will be in the future, but we can all likely expect that tax rates are not going down.

We also have no idea what return we will achieve on the invested $20,000, but history suggests that 6% (before fees) should be a reasonable expectation for a globally diversified and balanced portfolio (but remember, always, that historical performance is not a guarantee of future returns).

Fees: you have to make sure that whatever you invest in, that you are very cognizant of the costs of investing. 

If you buy (or your advisor buys for you) a mutual fund, what are his / her fees and what is the Management Expense Ratio (MER, found in the small print).

For example, the RBC Balanced Fund takes 2.16% (lower right of the above) for its troubles. It's 10 year return has been 3.7%. Add in the MER and it has been 5.86%, so close to the 6% before fees number that I suggested above, although they beleive that they should get about 2/3 of your return for their trouble.  Amazingly, $5.6 billion think that this is OK (that is the amount of money invested in the RBC Balanced Fund). 

Oh and by the way, at High Rock we can basically cut that in half and offer all sorts of inclusive personal service and fiduciary responsibility.

Most importantly, we will do a Wealth Forecast for you that will help determine if it is appropriate for you to borrow for your RRSP or not. For that matter, we can tell you if, given your personal financial circumstances, whether borrowing to invest makes any sense at all.

Here is my point: you can crunch the simple math and determine if that works for you. However in the larger context of your goals and objectives, time lines and risk tolerance, does it make sense?

Only if it fits into your plan. So you need a plan to determine if it makes sense, otherwise you are rolling the dice. Are you a gambler? Or are you a steward of your families wealth? 

Big difference.

Plan first.