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RRSP LOANS

Tread carefully on the borrow-to-invest treadmill

A look at the pros and cons of going into debt to feed your portfolio

Paul Brent

T.S. Eliot had it all wrong. February, not April, is the cruellest month. Winter's grip is strong, people are still coping with bills from the holidays and suddenly the financial services juggernaut gets rolling, delivering plenty of advice - often contradictory - about tax season and saving for retirement.

Financial institutions have turned those year-end RRSP loans into an annual rite of winter, describing them as a way to take advantage of all that unused contribution room that most of us have. Borrow today, buy some mutual funds for your RRSP and get a big, fat tax refund as a result, which you can use to pay down the loan. And of course let's not forget that with the stuffing beaten out of the markets, now has to be a great time to invest, right?

Juxtapose that advice with those of many financial planners and advisers who point to the historic levels of personal and household debt riding on Canadians' collective shoulders and the need for financial flexibility in this current environment of corporate cutbacks and anemic economic growth.

Opponents of the borrow-your-way-to-retirement strategy argue that taking on debt to save for a retirement that may be decades away makes little or no sense - especially if you already have credit-card debts or a line of credit.

"You would be amazed how many people do it," says Peter Andreana, a partner and certified financial planner with Toronto's Continuum II Inc. "How does it make any sense to save money that you don't have?

"That's essentially what you are doing: You are borrowing money to save," says Mr. Andreana.

Besides piling more debt and stress upon your household finances, the borrowing-to-save strategy can turn into a treadmill scenario in which you find yourself lining up year after year to take out loans to top up your RRSP contribution. Worse, Mr. Andreana points out, most consumers don't use that tax refund to pay off the loan more quickly. Instead, it goes to discretionary spending.

He also notes that taking out an RRSP loan is not tax deductible, so if you are paying 6 per cent interest on that loan, whatever you are investing the money in will have to recoup those interest costs and more to keep you ahead of interest payments and inflation.

And to top it off, if you make your RRSP contribution just once a year you are, consciously or not, engaging in a market timing strategy, something even Bay Street pros shy from. Who knows if February 2009 will prove to be a low point in the markets, but one thing is certain: those who borrowed to invest last February got the worst of both worlds - non tax-deductible losses in their RRSPs and, likely, lingering loan repayments for those under-water investments.

Mr. Andreana's advice is simple: step away from the borrow-to-invest treadmill and instead set up regular monthly RRSP contributions that you can afford, when you can afford it. "Minimize debt as much as possible starting with the highest-interest debt first," he says.

"Get rid of the credit card debt, get rid of the line of credit, start working on the mortgage debt as soon as you can - and then do your monthly RRSP contribution on top of that."

On the other side of the argument are those who say that leverage is great if you can afford it, that interest rates are low, and that the markets will have to turn around sooner or later.

"The reality is that when the markets drop 40 per cent from their previous overvalued peaks, that doesn't happen that often," says Talbot Stevens, a London, Ont.-based financial educator and author. You have to look back to the tech bubble implosion of 2001 and again in the mid-1970s for similar massive retreats, he says.

Mr. Stevens argues that it is only human nature to invest in markets when they are going up and that people are understandably wary about investing now with everything in the dumps.

"We are driven by fear more than logic," he says. "We don't know whether the markets are going to drop another 50 per cent. "We do know that it is 40-ish per cent safer than it was six months ago."

He likes the idea of borrowing to invest, especially now, but has a rather low opinion of the borrow-and-pay-it-off-with-refunds argument: "In my experience, coast to coast, 90 to 95 per cent [of people] spend the refund."

If you plan to use that tax refund to finance a decorating splurge or summer vacations, you are better off not borrowing to invest at all, Mr. Stevens says. "At the very least, do something productive with the refund. Reinvest it back in the RRSP if you still have room. Start paying down non-deductible debt is a good use of money as well."

The borrow-or-not question does not even get into the long-running debate about whether consumers should focus on reducing their mortgage or concentrate on building an RRSP nest egg.

Malcolm Hamilton, a pension actuary with Mercer Human Resource Consulting Ltd., strongly believes in the mortgage-first approach. While he sees the potential benefit using RRSPs to bet on the markets, "getting that risk-less, 6-per-cent return on mortgage repayment - that is really good in this environment," he says.

"That is a higher risk-less return than you are going to get almost other way and, for the first time in a long time, I think that people are beginning to appreciate that a risk-less return is worth more than a risky one."

Special to The Globe and Mail

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