After the seasonal marketing push for RRSP contributions that we recently seen exert its pressures the last few weeks, it struck me just how single-minded the whole thing seemed to be. While it’s true that not enough Canadians are using RRSPs (only 5.3% of the total contribution room across Canada was used last year) or any other type of savings for that matter, it is also incorrect to tell people that this should be a priority ahead of paying down credit card charges and other consumer debt. The numbers don’t make any sense for this at all, or rather they don’t make sense from the consumer’s perspective.
They do however, make sense from the salesman’s perspective. In this case the salesman is the banks. You see, no one makes any money off of you paying down your credit cards. That money has already been spent. If you run your credit card through your bank, then they are actually making money off of the interest you pay every month, so they are obviously not going to put a lot of energy into encouraging you to pay it off. This is especially true when they can instead talk you into, “Buying RRSPs” (I absolutely hate this false terminology that misleads us) which roughly translated means: buying our house mutual fund that will underperform the market, but will give me a big fat commission.
Boring Debt Vs Exciting Easy Money – No Contest
Financial advisors that work for the big banks make a killing off of showing people those fancy charts that show that you need 3.8 million dollars to retire at 55-60 like you want to, and that you NEED TO START SAVING RIGHT AWAY!!! There are 101 cliches out there about paying yourself first and saving 10% and all that jazz, and while these may have some merit when applied to an overall philosophy, they can cause a lot of financial damage when specific realities are ignored. From there, it’s just basic human psychology. Making easy money through these brilliant investments, and retiring to a winter home in Phoenix (like in those Freedom 55 commercials) is a lot sexier than paying down credit cards that have already given up the adrenaline rush that they once held. It’s a much easier sales pitch when you get to show compound interest working for you instead of against you.
This is exactly why the debate about RRSP contributions versus credit cards and consumer debt is not really an argument at all. It is simple mathematics. Please don’t let anyone try to sway you with a slideshow that looks like it could double as a Cialis commercial, and promises of living life golfing in the mornings and walking on beaches all evening (while you wait for the “right moment”). Anytime you have a consumer debt that charges interest rates over 7-8%, it really doesn’t make any sense to try and invest money instead of paying the debt off. The sole exception to this in my opinion, is if you own a business that is growing at an unbelievable rate, you are a risk taker, and all other credit options are exhausted. Personally, this isn’t my style at all, but I do know some people that can successfully advocate for using credit cards to fund business expansion in the short term. Any other time, paying down your consumer debt will give you a better Return On Investment (ROI) than your investments likely will.
You Want High Investment Returns?
To illustrate this point fully, one must look at the negative side of consumer debt. The interest rate that is charged to you on your debt means that every dollar you pay off of that debt is the exact same as if you had received that percentage in investment returns had you invested it instead. It is actually slightly better-than-even because it is more tax efficient (even investment gains made inside of an RRSP are taxable when they are withdrawn). Most financial planners today use an 8% figure when calculating long-term returns, and some are even smaller than that. If you had an investment option that could guarantee investors an 8% return, I think the vast majority would snap this up in a heartbeat, especially once the tax advantages are calculated in. Yet instead we choose to role the dice on the advice of bank-provided financial advisors… I don’t get it.
The people out there that are able to realize investment returns that are similar to the rates most credit cards charge are basically known as magicians. Warren Buffet has produced roughly a 20% yearly average return on his investments over the years. If you look at most credit cards, 20% is usually the average, and several store-specific ones are much higher than that! Don’t let someone convince you that it is smarter to lock your money away (especially in mutual funds) when you are paying large interest payments on consumer debt. If you have taken out an investment loan, or comparing student loan/mortgage debt and saving for retirement, then there are many more variables at play. This debt (often referred to as “good debt”) is a totally different ballgame, and you should definitely consider paying this off at a slower rate as you build an investment nest egg.
Before you succumb to the siren song of charts and ROI percentages, do the real math for yourself. Remember the cliche (one of the few personal finance cliches I actually like), “No one cares about your money more than you do.” Unless of course you are need of a good mutual fund recommendation…