You are strong. You have discipline. You strode by the Tesla kiosk and didn't put a deposit down on that new Model Y. You shuffled through an entire mall and there is not a single shopping bag in your hand. Ok, well just that one blouse, but it was an amazing deal at only $29.99.
And now you've got some hard earned savings you want to put to better use, to invest...somewhere, but where? In this article, we'll offer some practical guidance for where to put your money and why.
But let's get one thing out of the way. When you're thinking about "where" to invest, the "where" could mean two very different things:
- "Where" as in, say, a TFSA versus an RRSP versus paying down a loan, versus an RESP and so on. Let's refer to this as a location investment decision
- "Where" as in the stock market, a GIC, a bond, crypto, and so on. Let's refer to this as a product investment decision.
In this article we'll be focusing on the ideal location for investing your money and not on specific investment products (maybe we can talk about those in another article).
To do this as simply as possible, we're going to walk through an ordered series of questions you can ask yourself to help pinpoint the optimal location for your money. Let's dive right in!
...wait one more second...a word of caution. Most of the questions are pretty straightforward and have obvious Yes/No paths but, like anything in life, there are always exceptions (such as maybe first evaluating the need for life insurance or long term disability insurance) so be sure to consult a financial advisor if the decision path below is not 100% clear to you.
1. Does your employer offer a matching group RRSP plan?
If yes, put your money here first.
Why? Your employer is matching your savings (whether it be at 50% or 100%) and so you should always take this free money. Think of it as being part of your salary!
If no, or if you are already doing this, move to question 2.
2. Does your employer offer a share purchase plan with a discount or match of at least 50% or more?
If yes, put your money here next.
Why? Again, you can think of this as free money and another part of your salary. In this case you are being asked to buy shares of your company and this may mean greater risk and less investment diversification, but an immediate 50% (or more) return on investment should not be passed up.
If no, or if you are already doing this, move to question 3.
3. Do you have high interest consumer debt such as credit cards balances, car loans, or lines of credit?
If yes, pay these off.
Why? High interest debt is a drain on your cash flow and future savings rates and paying them off guarantees you a risk free rate of return equal to the loan's interest rate.
If no, move to question 4.
4. Do you have an emergency fund?
If no, save between 3 to 6 months of living expenses in easily accessed cash.
Why? Think of an emergency fund as a form of insurance. Rather than paying high interest rates to a line of credit, or worse, a payday loan, you’re paying yourself money by building your emergency fund that you can turn around and use in an emergency.
If yes, move to question 5.
5. Do you want to buy a home and you qualify as a first home buyer?
If yes, contribute to a first home savings account (FHSA).
Why? This gives you a tax refund on that year's taxes, the FHSA accumulates tax free, and funds can be withdrawn tax free when you buy your first home. Depending on your income, the tax refund is like getting immediate 25-50% return on your investment - more free money.
If no, continue to Question 6.
6. Is it an important goal to contribute to your child's post secondary education?
If yes, contribute up to $2500 per child per year to a registered education savings plan (RESP). The feds kick in another 20% up to $500 (thus the $2500 annual limit) giving you an immediate 20% rate of return. When RESP funds are withdrawn to pay for school, they are taxed in the hands of the student and, very likely, essentially tax free or at very low tax rates.
If no, continue to question 7.
7. Are you wanting to save for a short term goal like a vacation, new car, etc.?
If yes, contribute to a Tax Free Savings Account (TFSA).
Why? While a TFSA can also be used for long term savings, it's a great place for short term savings because you can withdraw TFSA funds at any time without penalty and, unlike a Registered Retirement Savings Plan (RRSP), the amount you withdraw from the TFSA will be available for you to put back in again the next year.
If no, continue to question 8.
8. Does your employer offer a share purchase plan with a discount or match of at least 15% or more?
If yes, consider putting your money here next.
Why? Again, you can think of this as free money and another part of your salary. In this case you are being forced to buy shares of your company and this may have some risk and less investment diversification, but an immediate 15% (or more) return on investment should at least be considered.
If no, or if you are already doing this, or don't want to do this, move to question 9.
9. Do you earn less than $60,000 per year?
If yes, you should contribute to a TFSA.
Why? Because you are in a modest or low income tax bracket, the tax break you receive by contributing to an RRSP may be no higher than the tax bracket you will be in when you need to pull the funds out. In other words, contributing to an RRSP will not give you a tax rate advantage. Plus TFSAs are more flexible overall than RRSPs.
If no, or if you have already made the maximum contribution to your TFSA, continue to question 10.
10. When you withdraw your funds, do you expect your income will be higher than it is today?
If yes, you should contribute to a TFSA.
Why? Because you will have higher income when you need the funds, the tax break you receive by contributing to a registered retirement savings plan (RRSP) will be the same or lower than the tax bracket you will be in when you need to pull the funds out. In other words, contributing to an RRSP will not give you a tax rate advantage and may even be at a tax disadvantage. Plus TFSAs are a little more flexible overall than RRSPs.
If no, or if you have already made the maximum contribution to your TFSA, start making contributions to your RRSP until you max out those too.
Why? RRSPs still offer tax refunds and tax sheltering meaning your savings grow tax free inside an RRSP until you are ready to withdraw them.
Now move to question 11.
11. Have you maxed out contributions to both your RRSP and TFSA?
If yes, congratulations! You have run out of free money options and you have tax sheltered any additional savings in TFSAs and RRSPs to the maximum allowable in Canada.
From here you will have to put your money in a good old fashioned tax paid account...at least until you go through this exercise again next year or when you change life circumstances such as a change of employment.
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