Investors often are conflicted on what to do with surplus cash. Your options for available cash usually fall into three categories: spending it, investing it, or paying down debt. While there is no one-size-fits-all solution for allocating cash, there are some tried and true principles that could help you decide whether your extra cash will work harder for you in your RRSP , TFSA, or on you mortgage.
What You Need to Know
Often when people come into some extra cash their first instinct is to pay down debt. While this is always the best option when it comes to dealing with high interest debt such as credit cards, mortgages can be a little more complicated. Mortgages are considered to be low interest debt, especially in today’s environment. Therefore, it is possible to get the best return on your dollar by investing the money where your rate of return could exceed the interest rate of your mortgage.
For example: if the interest rate on your mortgage is 3% but you expect that your investment could make 6%, it may make more sense to put your extra money into the investment. One reminder is that investment returns are usually not guaranteed and so actual returns may be lower than what you expect, while paying down debt will 100% save you the interest otherwise payable.
Investors can also use their RRSP to get a best of both worlds return. Depositing capital into your RRSP will allow you the opportunity to see your money grow, while simultaneously giving you a tax refund that can be put down in a lump sum on your mortgage to help you get even further ahead. Win-win! This is a good option if interest rates are similar or if your savings are lacking and are a top priority for you. This is especially a good option if you are in a high bracket for your income tax.
When it comes to deciding between a TFSA and a mortgage the options are more limited. While a TFSA does grow tax free, it is funded with after tax dollars and no tax refund exists for deposits. If your RRSPs are maxed out and you are trying to decide between your Mortgage and TFSA, then your decision may simply come down to your rate of return. For example, if you are 3% on your mortgage and you think that you can only earn 2.5% in your TFSA, the mortgage would be the best bet.
The Bottom Line
The best strategy for you will vary depending on your personal financial situation. Your financial advisor can help you weigh the pro’s and con’s in a way that will be tailored specifically to your situation.