Now that the last minute RRSP stampede is over, I’d like to suggest that there is a better way to manage your RRSP savings. The last two weeks in February, Canadians line up like lemmings to invest in an RRSP for all the wrong reasons, in my opinion. This, reinforced by several recent consumer surveys, found about 60% of us Canadians procrastinate until these last two weeks of February to contribute to RRSP’s. Apparently, waiting until the last minute has become a habit for too many of us, in that we postpone everything until forced to do something. For example, think about the time we waste fighting the crowds of last minute shoppers on Christmas Eve, or surfing the web instead of completing work related chores. Plus every new-year many of us plan to diet, exercise, etc. then end up not following through.
Which begs the question, how have so many of us ended up like this? A psychologist might answer that we tend to place a greater value on a short-term rather than long-term reward. For example, we spend money now on feel-good things like clothes, a vacation, dinner out, etc., and tend to put off adverse tasks such as banking, finances, or facing uncertainty. The risk for the real procrastinators among us is that we delay important things such as setting up an automatic monthly savings plan.
Doing automatic regular money deposits into a high interest savings account, RRSP or TFSA helps protect us from ourselves, and is a more effective way to grow one’s retirement savings compared to lump-sum payments. A benefit of this is that we mentally set this aside as money we can’t spend.
In my opinion, waiting until the RRSP deadline to make a lump-sum payment means that you are missing out on the potential to earn compound interest throughout the year. Consider that someone investing $200 a month for 30 years, at a conservative rate of return of 6%, would end up with retirement savings of about $195,045. Compare that to one deposit of $2,400 right before the deadline, they would only end up with only $137,540. That’s about $57,000 less!
Similarly, borrowing to invest in an RRSP at the last minute in my opinion is not the best strategy, especially for those who use the tax refund to fund a holiday or a new TV rather than paying down the loan. The interest is not deductible and the loan still has to be paid off. This is made worse where the loan proceeds are invested in a savings account or GIC with little growth potential. Setting up a monthly contribution directly into the RRSP is a more sensible solution and you avoid the RRSP stampede. Jim Yih from Retire Happy adds a little more detail to these thoughts in his article “What Happens After the RRSP Deadline”.
For those people who didn’t invest in an RRSP this year because they were concerned about market volatility, my suggestion is to sit down with a trusted advisor. You don’t want to miss out on the potential for long-term compounded investment growth. Plus long-term market volatility works to a patient investor’s advantage over time, a habit few Canadians seem to have developed, as many end up chasing returns by switching their investments into funds that did well last year, not understanding that developing a long term buy and hold strategy works.
And remember, RRSPs are not a piggy bank to be robbed every time some cash is needed! They are long-term saving plan intended to be used for your retirement. A TFSA is a much better way to save for those short term cash needs or emergencies.
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