Financial expert Markus Muhs in Edmonton says TFSAs are better vehicles for higher-risk investments than RRSPs, but investors always need to determine their 'stomach for volatility' before deciding on how risky to be.JASON FRANSON/The Globe and Mail
Call it a question for the ages. Whether it’s at 30 or 60, Canadians often want to know – what’s the best way to handle the money you save?
The choices can seem daunting, whether you have money that’s burning a hole in your pocket or you simply have a hole in your pocket, but nothing to burn. The answers are often different, depending on your age and goals.
“For Canadians in their 30s, it’s still a big balancing act,” says Paul Shelestowsky, senior wealth advisor at Meridian Credit Union in Niagara-on-the-Lake, Ont.
“Do you pay down debt, save for a house? Do you contribute to RRSPs [registered retirement savings plans], to RESPs [registered education savings plans] if you have children? Do you put money into tax-free savings accounts [TFSAs]? There are so many areas that demand disposable income, and there’s never been less disposable income to go around,” Mr. Shelestowsky says.
It may seem that way in many households, but in fact there’s lots of disposable income. Disposable personal income reached an historic high in Canada in the second quarter of 2018, according to data from the website Trading Economics. But Mr. Shelestowsky is correct that it’s important to make careful choices about money, because the ratio of household debt to disposable income also reached a peak among Canadians last year.
“I recommend a few rules of thumb to help navigate these waters,” Mr. Shelestowsky says.
“First, pay down bad debt, such as your credit cards,” he says.
If you’re closer to 30 than 60, you should also consider which type of savings or investment plan is best for your income right now. At 30, your income may be relatively low given your career position, but it’s likely to grow as you advance, Mr. Shelestowsky says.
“If that’s the case, save your RRSP contributions for later years when your income will be higher. You get less bang for your buck if you contribute to your RRSP when your income is low. Contribute those dollars to a TFSA instead,” he explains.
An RRSP can be useful for those with relatively high incomes; for the 2018 tax year, you can contribute up to 18 per cent of earned income, up to $26,230. The money put into an RRSP is not taxed until it is withdrawn from the plan.
TFSAs, on the other hand, do not defer taxes, but any profits gained within the TFSA are not taxed. For 2018, you can contribute up to $5,500 to a TFSA, but you can also catch up on contributions back to 2009 if you didn’t put funds in before.
Another important issue investors will face at different ages is how much risk they are willing to take.
“Ultimately how to invest comes down to an individual investor’s own stomach for volatility as well as their goals and time horizon,” says Markus Muhs, investment advisor and portfolio manager at Canaccord Genuity Wealth Management in Edmonton.
“If we assume the investor has all of his or her short- to medium-term goals covered by other accounts, then the TFSA is most effectively invested as aggressively as the investor is comfortable with,” he says.
It’s better to use a TFSA than an RRSP for riskier (but potentially faster growing) investments because the compounded growth will never be taxed, unlike the RRSP whose funds will be taxed as they’re withdrawn.
“My suggestion isn’t for investors to load up on risk in their TFSAs. But in an overall portfolio (with TFSA, RRSP, non-registered accounts and so-on), if an investor is going to have fairly risky assets anyway such as emerging markets or small-cap stocks, those assets are best located in the tax-free account,” Mr. Muhs says.
“Someone in their 30s, probably just starting to invest, will most likely be looking for growth,” says Neville Joanes, chief investment officer of WealthBar, a robo-advisor headquartered in British Columbia.
“They have a long time horizon to invest and can invest in equity-heavy portfolios using low-cost ETFs [exchange traded funds,” Mr. Joanes says.
Investors in their 40s or 50s might want a more balanced approach to capture market growth and also protect from negative scenarios.
“They’re in a stage of their career where they may be able to take advantage of their full room for RRSPs and can also put any extra funds into a TFSA. They can shield growth from taxes as well as income,” Mr. Joanes says.
“For the investor in their 60s, their shorter time frame means they’ll probably want to take a safer approach. That way, their nest egg is secure even if the market slides sometime between now and when they stop working. The investments they would focus on would be low-risk and stable especially in this rising interest rate environment,” he adds.
Regardless of one’s age, any investor should contemplate what might happen if they need the funds they have invested for an emergency, says Sandra Foster, Toronto-based financial author and president of Headspring Consulting Inc.
“For example, if a portion of the money in your TFSA represents some emergency fund or short-term savings, that amount might be kept in short term GICs so the money is there if and when you need it,” Ms. Foster says.
It’s also worth looking at how to keep your TFSA out of your estate by naming a successor holder or beneficiary, Ms. Foster adds. You can’t take it with you, but you have some control over where it goes.