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I recently received an e-mail from a reader named Lance who finds himself facing a dilemma. He is young, has a good job, and intends to start putting some money aside. However, he wants to save for more than one goal.
Since the time horizon for the TFSA is quite short, the money should be invested conservatively. This is a low risk/low return scenario. The portfolio should not be exposed to the possibility of significant loss because there is very little time to recover. Safety of capital trumps big returns in this case since he only has five years to work with. Lance should invest most of the TFSA money (say 60 per cent) in fixed-income ETFs or mutual funds, with the rest in dividend-paying blue-chip stocks or funds that invest in them.
The approach in the RRSP should be quite different. This money is being invested for the long term, so growth potential can take priority over safety, at least until he reaches his late 50s. That suggests a portfolio that is more heavily skewed to equities in the early years. As retirement approaches, the asset allocation should gradually become more conservative.
Another option is to use the RRSP Home Buyers’ Plan (HBP). In this case, Lance would put all his savings — let’s say $ 5,000 a year — into one RRSP account. When he’s ready to buy a first home, he can borrow up to $ 25,000 from the RRSP to use as a down payment. It’s an interest-free loan, repayable over 15 years.
There are two points to keep in mind here. The first relates to investment strategy. Instead of taking a growth-oriented approach from the outset, Lance would have to be more cautious (as with the TFSA) to ensure that the down payment would not be eroded by losses. Only when the loan money is safely withdrawn can he become more aggressive.
The second problem is the long repayment time. Because the loan is interest-free, many people will be tempted to repay only the minimum amount each year. That will reduce the end value of the RRSP.
For example, suppose Lance contributes $ 5,000 a year to the plan and intends to retire in 35 years. If he chose not to use the HBP, he could focus on equities from the beginning and earn, let’s say, six per cent annually. By the time he is ready to stop work, the plan will be worth $ 557,174.
If he intends to use the HBP in five years, he’ll need to be more conservative at the start. Let’s assume his money earns only three per cent during that time. When he is ready to borrow, the plan would have $ 26,546 in it, or $ 1,546 after the withdrawal.
Let’s assume Lance repays the loan at a rate of $ 1,667 over 15 years and adds another $ 5,000 a year in new contributions for a total of $ 6,667. Once the loan is repaid, his yearly contribution returns to $ 5,000. He becomes more aggressive in his investing and earns an average annual return of six per cent for the next 30 years. At the end of 35 years, the total amount in his RRSP is $ 497,159. The cost of using the HBP is a reduction of $ 60,000 in the final value.
My advice to Lance, therefore, is to open an RRSP account and use it for both purposes. It’s easier than juggling two accounts and if he pays off the HBP loan at a faster rate, the loss to the end value of the plan will be significantly less.