Q: I will be coming into $60,000 in the next month or so. I will use about $10,000 to pay down my line of credit (LOC) and credit card. I already have a TFSA account with lots of room to add more money. I also have a small investment account with my bank, which has earned $44 on the $600 I put into the account five years ago. I am not very versed on financial matters so, where would be the best place to put the extra money? TFSA? GICs? A bond fund? I am six years away from retiring, but I plan to work well past age 65. I have no RRSPs and want to be able to have access to this money so I can draw on it intermittently if I need it. Your guidance would be appreciated.
A: Investing a large sum of money can be a daunting decision so it is important to get advice. Let’s go over your options:
Before paying down debt it is always important to take a look at the pros and cons. Paying down a debt at an interest rate of 19% like a credit card is a debt you want to pay down. A debt like an LOC that may only be at prime (currently 2.7%) is something you want to consider leaving in place and using the money to invest. If you paid off $10,000 on an LOC at 2.7% in interest you will be saving $270/year. If instead you took that $10,000 and invested it and generated a rate of return of 5% you would earn $500 for the year. That’s net $230/year in your pocket ($500 investment growth less the $270 interest charges), and when you compound that over 10 years your $10,000 investment will be worth $16,470 and you would have paid about $2,700 in interest on your LOC, so you have gained $3,770. Risks need to be considered since that 5% growth is not guaranteed but in general, you want to take every opportunity to make your money work for you—not the other way around.
When it comes to choosing your investments here is what you need to know:
GICs and bonds
GICs and bond funds can be bought in TFSA, RRSP, and non-registered accounts. If your main focus is capital preservation, then a GIC can be useful. However in order to get a decent rate of return you need to keep the funds in for a five-to-10-year term. Since having availability to access funds is important to you I do not think a GIC is the right fit.
Having a diversified portfolio is key in managing risk while maximizing your returns. This means investing in a mix of equities, cash, and fixed income instruments that are customized to your investment objectives.
From what you have told me you have room in both your RRSP and TFSA. These tax-advantaged investment vehicles are going to be your best option. Let’s go over the advantages and disadvantages of both.
The benefit of investing in an RRSP would be to get the tax refund and tax-deferred growth of your investments. If you haven’t invested in an RRSP yet I would assume you have a fair bit of room available. By investing $50,000 into your RRSP you can potentially get back over between $10,000 and $20,000 in taxes. You can then use that money to either further invest into your RRSP, into another investment vehicle or pay down any loans.
The disadvantage is when you pull the money out you will need to pay income tax on the withdrawal. This can be an advantage or a disadvantage depending on marginal tax bracket when you put the money in versus when you make the withdrawal.
The benefits of investing in a TFSA is tax-free growth and flexibility. When you withdraw from a TFSA you won’t pay any tax and you won’t lose your contribution room either (you just have to wait to the next calendar year to regain the room). The disadvantage is you won’t get the tax refund as you do with the RRSP, therefore not getting that extra money to start working for you now.
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