It’s a common conundrum facing the average Canadian with limited savings; each year they wrestle with the same nagging "pay RRSP or mortgage" question.
And every year when they ask for professional advice they hear the same answer, as illustrated in this article in the Financial Post: It’s important to save for your future retirement, so use your extra savings to build a retirement nest egg. (In other words,most experts don’t believe paying down your mortgage to be the right answer.)
But guess what? The stats are now in from the past 15 years and Wow, did we ever get it wrong! (I say “we” because as an investment advisor for over 20 years I was also guilty in ignoring debt repayment as a priority!)
Using what we know today about mortgage rates, and investment returns over the past 15 years as a guide, the answer to that old question is now much clearer. The correct answer is to forget about your RRSP until after you pay off your mortgage.
To make this a simple exercise, let’s make some practical assumptions about the following details regarding the basic finances of an average Canadian investor:
Next, let us make a few basic assumptions about your mortgage:
Finally, let’s make a few basic assumptions about your RRSP savings:
Note: According to BlackRock, a prominent asset management firm, the average investor earned 2.10% over the past 20 years. So if your RRSP investments averaged less than the 10.51% used in this example, the numbers are even stronger for ignoring the pouring of your savings into an RRSP until after you pay off your mortgage.
The following chart summarizes the calculations for an average Canadian.
Note: The calculations for this article use factual historical numbers for mortgages and investments that we have plugged into InvestingForMe’s new Mortgage vs. RRSP Calculator that conveniently calculates which investment makes more cents. To plug in your own personal finance numbers, simply click on this link.
The numbers in the chart above clearly demonstrate how paying off your mortgage first will save you a lot of money – that’s savings of $108,801.03 in actual, out-of-pocket expenses by ignoring your RRSP until your mortgage was paid off! Or to put it in more tangible terms, that’s $7,253.40 per year or $604.45 per month for 15 years in savings! I don’t know about you, but to me that’s a lot of money to throw away unnecessarily.
Plus, after 15 years, your Accumulated Value (after-tax) of the Mortgage Savings would equal $161,206.30. That’s $52,202.30 more than your Accumulated RRSP Value (after-tax) of $109,004.00.
And yet most of us continue to roll along contributing to our RRSPs first. Why?
If you’ve been following the standard advice and deposited your extra $4,670.00 of savings into an RRSP and invested it like a god (best case scenario as outlined above),
Here’s what the stats from the past 15 years are actually telling us
If you had actually ignored your RRSP and used your extra $4,670.00 in savings to pay down your mortgage each and every year for the past 15 years, here’s what you’d find:
Bottom line: paying down your mortgage makes more cents
So, if you decided to pay down your mortgage instead of contributing to an RRSP, your mortgage would be paid off, and you would have saved $108,801.03 in bank and investment costs. This huge savings mean even more possibilities:
So, What Should You Do This Year?
Paying down your mortgage instead of contributing to an RRSP seems to be the answer that makes plain sense (and cents)! There’s really something wonderful about being debt-free, not paying the bank and investment pros$108,801.03 in fees and interest, and gaining a better sense of control that comes with greater financial security. Imagine the tremendous relief in simplifying your financial life:
And how do you know whether these conclusions should guide you for the next 15 years? Well, no one knows the future (advisors included), but ask yourself a couple of simple questions:
So, in light of these answers, I would still highly recommend paying off the mortgage first. Oh, and by the way, this concept is by no means a new one. It may be new to our generation, but not to our parents and grandparents who always paid off the mortgage first. They’d never sock money into a savings account while they still owed the bank. To them, that would have been downright stupid!