The couch potato approach

Passive income is, in my opinion, a critical element in achieving financial freedom. But some of us also would like to have some sort of “shoot and forget” investment plan, if possible. Something that does not require the baby-sitting that stock manipulation (and speculation) demands or it is not as time consuming as having a rental property. Enter the couch potato approach: just sit down and watch your money grow.

Most small investors out there know what the couch potato approach is to investments. But if you have no clue what I am talking about you can find good starting points here and here. The Canadian Couch Potato website is a very good source and it does provide you with all the information you need to succeed in this investment approach. The Money Sense webpage has also a very thorough explanation of how to invest your money without tweaking it too much.

My opinion on the couch potato investment technique is simple: it works but the time frames might not be that great. The basic principle of investing the money long term on basic indexes like the S&P 500 for example, is that if you cannot beat the market, just join it. The couch potato approach is good because you save tons of money in management fees and you can expect to be performing better than many aggressive funds that usually take a dive on bearish markets (2015-2016 comes to mind, but 2009-2010 is another great example). And you might also perform better than many conservative funds that rely on bonds as well.

Another great advantage of the couch potato approach is that once you re-balance your portfolio, you only need to worry about it after a whole year. Why keep up with all the market news if you can perform decently by managing your portfolio for 1 hour a year? It is low maintenance, provides solid returns and it is cheap. So, what is the catch?

Well I can see two issues:

First, on bullish years the performance is great. But as indicated in the moneychimp.com site, depending on your timing you can barely beat inflation. For example, from 1965 until 1981 the average rate of return was 3.55% a year. Not horrible, but not fantastic either. I am pretty sure there were better options available during that time. In some cases, you can be really in trouble if you have your whole portfolio on it, since some years could wipe all your gains from previous years easily with 2008 (-38.49%) being a good example but the 2000-2002 period with a -15.52% return also providing lots of of evidence that you cannot follow the markets 100% of the time or you might be in trouble.

Obviously that no one would recommend you to heavily invest all your money in one specific index, but the problem is that by having your money in a few indexes won’t help you that much because with the global economies so interconnected, when one index falters, all others usually follow. I would go TD Canadian Index Fund and Nasdaq instead of doing what was recommended on this page in order to better diversify, but the truth is that you are still not immune to the bearish market moments.

The second issue with the couch potato approach is, like I mentioned, time frames. I like to have liquidity and this approach works best on the long run. If, for any reason, you have a better investment opportunity or you need the money all of the sudden (life is full of surprises), you might have to take your money on a bad year or period of years and you might end up wiping all the gains you had before. This is true for all investments but to have a pile of money sitting on the same thing for 15 or 20 years is not exactly that flexible like jumping out of a bad mutual fund at the wrong time.

Have said all this, I personally would like to allocate a small chunk of my portfolio to something more couch potato like. Once I do it I will report here which funds I picked, why and how well they are doing (well, that will take a whole year for the first report anyway). A return beating inflation is all I expect from it and it might end up performing much better than my bonds though I don’t expect it to beat my customized stock portfolios. I recommend all small investors to educate themselves on the subject and consider this investment strategy even if it is just for the savings in management fees (which is why I wrote this article here too).

 

 

How do I cover my extra expenses

I have not talked yet about day trading or swing trading but I use stocks to pay for expenses that are considered out of the ordinary. Day to day expenses like shopping for groceries, property taxes or clothes should be taken into consideration in your regular budget. But other expenses like travelling, paying air tickets for relatives to come visit you (common thing when you have a baby), buying a small boat or a motorcycle, should all be paid with extra money you make from short term investments, if possible.

I use my TFSA (US residents are out of luck here), to cover for all those expenses. The reason is because I get the money I need tax free from my TFSA investments so it is much easier to afford that trip to Italy. Taxes eat a lot of the disposable income you need for those one-off expenses.

If I want to spend money on something like a trip or a renovation, I check how much it is going to cost me and I do day trading until I get the money I need. It is risky and it is not for anyone I admit. If you are not careful you could end up with less money than you initially had. But this process gives me the comfort of knowing I am not digging into my savings or using money from my regular income (which should go to pay my bills and to my retirement fund). I consider all those extra life events as a special project that requires new capital. And the capital comes from my day trading or, in other words, from other people.

I’ve been spending lots of time studying about day/swing trading and I will post later my reviews on some webinars and courses I am attending on the subject. The idea is to be good enough at day trading to be able to afford all those additional costs throughout the year. Even my backyard renovations money will come from day trading.

I am not advocating anyone to pay everything from stock manipulation, and I am not saying that I will be able to pay for everything 100% with day trading. But I am saying that I can drastically reduce the amount of money I need for something if I day trade. In fact, I can cover 100% of most of them. The key is to define your goal ($) and have a strategy to get it. By that, I mean that you have to decide how fast you need the money, if you are going to try to get all the capital from day trading or just a percentage of it, and how important the event is.

Until I make the money I need for the project, I don’t do it. That is an important point of my strategy. It doesn’t work for everyone but I prefer NOT to travel to Europe for 2 months if I cannot afford it. Some people have a different sense of urgency and have their personal reasons to go on that trip regardless of costs. In my case, I can afford to wait a few months or a year to do it (for most things, not everything), so I play with day trading until I get the capital I require. Once I have it, I pull it out of my TFSA to a saving account or chequing account and use it. I do not keep hoarding the money indefinitely. I actually spend it like planned (life is short and your goal has been achieved, don’t get to greedy and enjoy life a bit).

I recently paid for all my wive’s relatives as well as a friend to come visit us from South America with money I made day trading. It was not cheap and took me 3 months to get that money but she is happy and the money was not even mine. I took the risk with my own cash but it was a calculated one, and most of my trades were successful, though it took a few of them to gather all the money I needed. This is not the same as having enough passive income to be able to afford everything I want in life. This is using tax free investment money to focus on a project that requires a substantial capital and get it done in such a way that you don’t have to use your savings or income to cover for it.

Once you get into this habit of getting your extra expenses covered by short term investments, you start to plan things better, your savings are protected and you still get to enjoy everything you want to do. If you have expenses larger than a few thousand dollars coming soon (like spending more than $200,000 to buy this original Indiana Jones movie whip, for example), than you might have enough cash to not be concerned about the small investor tips I am providing here. But for most of us out there, to have our extra expenses covered by well invested money is a good plan.

 

 

Why trying to “fix” wealth inequality doesn’t work

Income and wealth inequality is a trending topic nowadays, especially among left wing parties and people that truly believe socialism works. I have a serious problem trying to understand why wealth inequality is such a big deal. In US the debate has been discussed ad nauseam by the democratic candidate Bernie Sanders, but in Canada it is a major issue as well since the Liberal government decided to increase taxes in the upper brackets and lower the taxes in the middle-class bracket. Sounds like a good thing but it is not.

I agree that the concept of trickle-down economics is a fallacy, but so is the idea that wealth inequality needs to be fixed. This is not a social problem, nor a political one and not even an economic problem either. It is pure math.

Assume two individuals, one with $1,000 to invest and one with $1,000,000 to invest. They both do very well in a year and get the exact same returns of 10% on exact the same mutual fund by the end of the year. The first person got $100 richer and the second one got $100,000 richer. Now the gap between the two just increased from $999,000 to $1,098,900. Simple right?

It is amazing that the people advocating for increased taxes on the rich cannot see this (and in Canada a person is considered to be part of the 1% richest if they make more than $175,000 US dollars a year). Given the same opportunities the people with more money will always benefit more and the gap widens exponentially forever. And that is my problem with trying to tax wealthy people like they do in Canada because the gap will not be filled by giving a tax break of 1.5% to the guy making less money, like the Liberal government did in the last budget (decreasing their RRSP tax break as well).

The gap will NEVER shrink. In fact, taxing people on more than 50% of their income like they do here only makes people less willing to invest. Investors like Murray Edwards, for example, simply leave the country and take their money with them. Disposable income is what fuels the economy, not handouts. The math is so simple that it makes you think what the political motivations really are behind those budget moves from the government.

The truth is that politicians want to stay in power. Creating jobs is way more work than giving other people’s money to those who make less. You guarantee a vote in your next election and you can always make promises you cannot keep because the money is not yours. Margaret Thatcher once said: The problem with Socialism is that it eventually runs out of other people’s money. She was right.

I know lots of people that prefer to work harder and invest smarter to make money instead of depending on government handouts. Some people truly need government support and it is good to live in a country that takes the poor and those in need into consideration. But to lie by saying that the handouts and over-taxation are here to fix the wealth gap between the poor and the rich, that is a simply disingenuous. In Canada, the secret to small investors seems to have money stashed somewhere but have a very low income coming from it (dividends come to mind). If that is the way to do it, then by all means let’s do it. How it benefits the country is another matter…

My Experience with Lending Loop

A few months ago I decided to check out the (new and first) Canadian peer-to-peer website Lending Loop. I was excited about the idea of lending money to small businesses across Canada and charge 10% or more in interest rates. In fact, I was thrilled. Most of those businesses have way higher interest payments to make to banks so peer-to-peer lending is a win-win situation.

I setup an account but it took a few days for me to have access to the money transfer portion of it. Once that happened I transfer some funds to it (small amount for testing purposes) but it took another week and a half for the money to show up in my account. I was started to get a little worried but when the cash was showing on my profile I was really eager to proceed with my experiment so I decided to browse the list of companies I could lend money too.

This is when I saw the difference between peer-to-peer (or anything else actually) in Canada and in the US. The first problem was that I only had two business to lend money too. Both of them would pay a very good interest rate (12.5% and 11%) and both had enough pledges to cover almost 100% of the asked amount on them already. I chose the one with the shortest lending period (18 months), confirmed my pledge and waited for confirmation that the company successfully got 100% of the money it needed.

Once I got an email a few days later saying the pledge was successful and the calendar for the payments start to show on my account I was very happy. The system seems to be very streamlined and I am still receiving the payments as promised. This is literally the most passive form of investment I ever got into. For the next year I will receive free money that magically shows up in my account at Lending Loop and I am be able to transfer those funds back to my regular bank any time I want.

lendingloop2

Not everything is great though. Canada has a way to prevent people from making money all the time. Last month, I got this notice from Lending Loop by email (also showing on their website now):

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I am glad I only put a small amount there to test. I knew this kind of thing could happen and although I am not surprised, I am a little concerned for the future of this investment option. Canada is always lagging behind when it comes to products and services and the monopoly of the Canadian banks is evident in this case (for those of you that have no clue how bad things are here, international banks are NOT allowed to operate in Canada, creating a cartel of a few banks you can choose from) .

Still, I think this is a great investment opportunity if the regulatory framework is approved. There are lots of people out there with money to lend and many Canadian businesses operate almost always in the red (sad reality). Despite the hiccups and the potential shutdown of the website I have to say this sounds like a good alternative for Canadians that want some passive returns.

Below is a list of Pros and Cons I compiled for those of you interested in peer-to-peer as a way to diversify your portfolio. I am assuming everything will still work fine and that in the future similar websites and companies will offer this kind of service.

Pros:

1 – Amazing returns.

2 – Easy to setup and easy to see all the companies available at the marketplace (page where all businesses describe what they do and what the money will be used for).

3 – Companies are screened first for risk and Lending Loop does all the leg work for you regarding contracts and everything else. You just click two buttons to make a pledge and it is done.

4 – You can spread the risk by lending smaller amounts to multiple companies instead of putting all your eggs in one basket.

5 – Support was fast when I emailed them.

6 – Monthly payments!

Cons:

1 – Lending Loop charges 1.5% of the total interest earned. Sounds like much but not when you lend money at 10% or more. Also, that is how they make their money. Still, it is a big MER compared to some other investment options.

2 – In Canada, people are still unaware that peer-to-peer lending exists. That means very few businesses to choose from right now. Sometimes they have all companies fully funded and you have to check again at a later time. Hopefully this will change in the future.

3 – Some loans are simply too long. I cannot wait 4 or 5 years to get all the principal back. I am not a big bank that can afford to wait so long and the longer the payments take, the higher the risk of the company defaulting on payments. Small business in Canada (especially restaurants) are so volatile that sometimes it seems like they opened their doors just to see how fast they can go broke.

4 – Like in any investment there is risk, but in this case it is hard to assess it properly. The company needs to describe what they do and explain why they need the money. They have pictures to show and websites you can go to. But it is very hard to evaluate the financial health of those companies with just that info. Like I said, Lending Loop does that for you but I like to have more detailed info (like I have when buying stocks).

5 – To create substantial passive income you need to invest a lot of money. But different than other investment options, this is still on its earliest stages of implementation in Canada so I would not risk large amounts for good while.

6 – You cannot use Registered Accounts to invest like RESP, RRSP or TFSA. That means taxes will hurt more.

Some of these drawbacks likely exist in some peer-to-peer sites in US as well but the market for this kind of investment is much bigger there and in the UK so you have more options and even the chance to compare sites. Canada is still starting to develop the regulations and I think it will be a few years until I am completely comfortable with peer-to-peer here. We also only have Lending Loop as far as I know so it is hard to compare it with anything else. Nevertheless, it is a great way to invest your money and watch it grow. If you are OK with not being able to properly evaluate risks and with the uncertainty on the regulatory side, peer-to-peer lending in Canada is a good option for you.

Why I drive an old car…

Well, not very old. It is a 2006 KIA Spectra. When I got it back in 2013 it was not exactly a piece of junk like my old Plymouth Neon 1997 that was running well until it fell apart (literally). But it is a car that for many people in north-america is simply not good enough. I know dozens of people that got a certain amount of money in life and decided that it was time to buy that Cadillac they always wanted. Some got Audis, Porches, BMWs, etc.

Though many of those people are very wealthy and can afford such vehicles, many others got a decent amount of cash but they will still have to work for a few (or many) years more before they can retire. What surprises me is that people don’t mind doing the grind of 8 AM to 5 PM everyday for another 3+ years just because of a car. I understand people require vehicles to move around in most north american cities (which is unfortunate), but those vehicles don’t need to be expensive in my opinion.

The sad part is that many young people I know (in their 20s) have cars that cost more than $35,000.00. Some of them cost close to $50,000.00. They buy depreciating assets that cost thousands of dollars a year in maintenance and insurance, some pay deductibles over $1000 when their car gets damaged (common site on our Canadian winters) and they think this is normal. I have friends that got trucks to haul around trailers, construction tools and whatnot, but they only do this a few times during the year. It would be cheaper to rent a truck for such occasions, but they still find “convenient” to pay $65,000.00 for a truck that will be under-utilized until they need to be replaced again for something even more expensive.

Call me cheap but the reasons why I have an older vehicle seem reasonable to me:

1 – I don’t care if my car gets dented, bumped or lightly scratched. I know a guy that had to pay $3500.00 just to fix the mirror of his BMW when he hit it against another car leaving his building.

2 – Insurance is cheaper since I am a careful driver and I don’t need complete coverage for my vehicle. Only third-party damages.

3 – During Canadian winters, all cars look like crap anyway because of they are so dirty you can’t even tell their model or color.

4 – My car can be fixed for cheaper and its regular maintenance cost is much smaller too. The price of an A/C repair on a Porsche is probably the price of my car.

5 – Many new cars depreciate in value fast. Any dents on them will make them lose value even faster. Accidents can actually kill the resale value of your vehicle. My car will only be replaced when it dies or when the maintenance costs get to a certain percentage of the car market value.

I do understand that many people in Canada and in the US love cars and this is a passion more than a mere case of moving around. I see cars as a mode of transportation not as a fun, cool thing to enjoy. As long as they take me from A to B safely I am fine with it. But for many individuals out there is more than that. The problem is that they cannot afford fancy cars at all but they still get one because they like it. Screw the consequences!

Here in Alberta, with the economy as deteriorated as it is, people still make the mistake of purchasing what they cannot afford. And I know two cases of couples that had to sell their vehicles and buy something cheaper (and still expensive on my point of view). I also always pay cash for my vehicles though I inspect them very well before buying them. Most people I know lease and replace them every 3 years. Which is the same as renting to drive which makes even less sense. It is a small mortgage. If you need your car to work and it is an expense for your business that is fine. But for leisure only? I think my car costs too much to run every year and I only spend around $40 every 6 weeks in fuel and $960 a year in insurance for 2 people to drive it. If you can keep your car running for 3 or 4 years it is all you need to be ahead of the game against leasing (numbers vary of course, each case is unique). I usually keep my cars for 7 or 8 years. I know people that have the same car with low maintenance costs since the late 70s (but the guy is a mechanic).

Regardless, my point is that you can always buy that fancy vehicle later once you can afford it comfortably. Don’t get into this expensive car trap before your are truly ready. If you are young just avoid the temptation altogether. Get used to something simple, cheaper and dull. It saves a lot and in the long run helps you build those extra savings much faster.

 

 

Investments options just a few clicks away

The list below shows what I think it is accessible by most people through their online banking. I have all those options available to me at RBC and I know that Scotia Bank and TD also offer the same tools. When I created this list I was trying to simply check  where I could invest my money and what I had to study in order to start making some money. I describe quickly what I think of them below and in future posts I will talk about my personal experience on those I tried.

Hedge Funds – Used to be for very rich people. Now in Canada they are available if you have a certain minimum amount in your portfolio. Requires a lot of research on the specific composition of the fund. They are not as safe as some people think.

Growth Stocks – I have one of those stocks but I am switching most of my equities to dividend paying stocks or to day trading stocks. Growth stocks can be the most powerful tool for your portfolio to grow if you pick the right candidate (Facebook, Amazon, etc). Takes time and you have to jump in almost at the beginning of the company’s development. But can give you amazing returns (imagine who bought Apple in the 90s or Google/Alphabet 10 years ago).

Short Term Stocks/Day Trading – I use my TFSA for this since all gains are not taxed. Requires a lot of research and it is not for the weak. I will talk about my experiences with Day Trading later.

Penny Stocks – Same as Day Trading but much riskier. This is for the very knowledgeable person, though I made some money from it on some specific energy stocks. People say that unless you are an inside trader you cannot make money from penny stocks without being very lucky.

Dividend Paying Stocks – A good part of my portfolio is now on this class of stocks. From some I get cash and for some I subscribe to DRIP (Dividend Reinvestment Plan). Requires research and diversification is key here.

Certificates of Deposit/GICs – Not my cup of tea. Slow growth of your capital and medium to long term commitment. I like liquidity so I shy away from GICs and CDs. If you have nothing better to do with your money and the market is too volatile you might want to park some money here. I don’t recommend it if your goal is aggressive growth.

Mutual Funds – I am not a big fan since Mutual Funds usually carry a high MER (percentage indicating the total operating expenses of a fund). Some are really good but you need to research A LOT in order t pick the right one for the current market. They provide the illusion of diversification so be careful with them. I will discuss about diversification later. I have some funds for my kid’s RESP.

P2P Loans – The idea is very interesting. Works like crowd funding, but for loans. High interest rate. Canada has Lending Loop but in US they have others like Zopa, Lending Club and Peerform. I invested $1000 on Lending Loop for testing back in January and will report on that in a few weeks. Canada has some regulation issues with peer-to-peer lending though.

Real Estate Rental – Yes, you can manage all your rental properties online if you want them to be vacation rentals and not a permanent one. VRBO. Requires real-estate experience and is a lot of work to manage and understand all the moving parts. It also requires a high initial investment and the commitment is very long term. Very good source of passive income if done properly. Of course you need to have a property first in order to do this so it is not exactly a few clicks away. You also need someone for the maintenance if you have no time to do it yourself. But it can be 95% managed online once the property is ready to go.

ETFs – Exchange Traded Funds. They did not perform very well in 2015 and so far they are having a tough time in 2016 too. Opt for those with dividend payments if possible and be careful because they charge less then Mutual Funds usually but there might be hidden fees in some of them. ETFs are a huge topic to discuss but I am not comfortable yet to talk about it as I have not yet decided in which one, if any, I will put my money into.

Corporate Bonds – In Canada they seem like a good option since our interest rates will not go up anytime soon and many companies are going through a rough time and some yields right now are very high. Many people moved away from them and their price dropped quite a bit. Offers less risk than stocks and some have maturity dates in less than 2 years.

Of course even bonds have a certain risk but if the corporation you invested in goes tits up you might get your money back since you are a lender. People that hold debt from a company usually gets paid first. However, most companies have their bonds classified as JUNK so be aware of the risk and check the company before investing. This is not the way to go right now in US though since the FED is moving interest rates up. Better put your money on something else at the moment. Requires lots of research to pick the right one.

Federal Government Bonds – Same as above but US and Canada government bonds are almost all AAA rated instead of JUNK. Very safe but with very low returns. Good option for older investors that already reached their primary financial goals.

Municipal Bonds – Same as Federal Bonds but the rates are usually not AAA. Montreal offered some bonds with over 5% yield and decent grades recently. I would avoid this kind of product though due to the inherent risk of bad city management. In US, it is even more dangerous. Look what happened to Detroit…

Money Markets – there are many different options of Money Markets. Works like bonds but the time frames are much smaller. The returns are usually very low too. Because the debt needs to be paid faster, money markets are usually safe to invest into. I have so far zero experience with them but I am researching if they can provide some decent short term returns if I invest higher amounts.

Currency Exchange – Though I made some money by buying other countries currencies in the past, I would not recommend anyone to invest in FOREX (Foreign Exchange) for Day Trading or even for medium term. It is very risky since currencies are news driven and the fundamentals of a country can be crushed by one simple announcement by a politician. There is, however, good money to be made here if you accept the risk.

IPOs – Initial Public Offer. Same as buying stocks but from companies that will move from private to public. Requires extensive research and, in some cases, good contacts inside the company. I made a lot of money with this and I know people that got very wealthy in the Oil & Gas industry because of it. Not every story is a success though. I get IPO offers on my RBC account almost every week.

The list above is not supposed to be extensive but it there to provide some options that people forget, ignore or simply never heard of before. They are all a click away most of the time. The idea is to study each one of them, if they appeal to you somehow, and to start making some money. All these options have many sub-options inside and some subjects, like ETFs, can be too complex and extensive for some people. I would check them by risk first and them work with the ones you seem to understand better.

Saving, Saving, Saving

The marketing guru Rory Sutherland says that if online banking sites had a huge red button on them that saved $100 of a person’s money every time it was pressed, people would save way more than they normally do. This is a case where the interface dictates the behavior.

Unfortunately this behavior is uncommon on the general population. The only people I know that save money are my friends that are interested in retiring at 45. Every single other person sees leftover money as cash to spend. But they have no clue how easy it is to save money and how much you can actually have after a few years of savings.

I am a very aggressive saver. And I recommend you to be the same. You should be saving around 40% to 50% of your salary or income if you really want to be ahead of the game later in life. For those of you in your early 20s that is even more important because of the new millionaire rule: $3.5 Million is the new $1 Million. Currently 30% of my portfolio came from savings. People thing I am being cheap or that I am the only person in the world that can save so much of my income. The truth is I had this habit since I was a teenager and I don’t regret it for a second.

The trick here is to create a separate account for your savings. I look at it as a temporary place before the money is moved into one of my investment accounts. And this saved money is NOT for a trip to Hawaii, not for a big barbecue party, not for a new car (I will discuss how to handle those types of expenses later). This saved money is there to generate more money for you.

To save in order to get $3.5 million or any other amount you want in that range sounds like an impossible task. If you make $45,000.00 a year how the hell are you going to save so much money? The idea is simple: you won’t get the full $3.5 million. But you need to help generate that amount somehow. If you can save only 10% of that, you now just need the other 90% so your investment work just became easier a little. And that 10%, if invested wisely, will generate another 40%, 50% or even more.

When I moved to Canada I had exactly C$13,000 with me. That is all I had to start a new life from scratch (for 2 people), without knowing anyone else. I had no job, no networking, no prospects, not even a place to stay. 12 years later and $13,000 is the price I paid in cash for the renovations in my backyard. I don’t expect people to go to the extremes I went to in order to save money (like having no furniture at all for a few months because I could not afford it). However I do expect you, as a small investor, to understand that without saving aggressively you will make your goals of financial freedom MUCH harder.

I cannot stress this enough: saving is one of the pillars of being financially free. Do not underestimate the power of that saving account temporarily holding your investment money. I personally love to see that amount grow over time. I really enjoy it. Get into the habit of going through this process and always ask yourself if the money you are going to spend on a purchase right now is really that critical. Spending extra money is the default behavior of 90% of the population. Do you want to live like 90% of people forever? I bet they are not as relaxed and happy as their Facebook photos are showing.

Setup a saving account, create specific $ goals and once you have achieved them you can start investing for real.

 

 

 

RRSP vs. TFSA

I have to say that I am quite surprised this is even a discussion. For me, the answer is very simple: TFSA wins.

Before we start fighting like an old couple trying to find parking close to the Walmart entrance, here is the basic point about RRSP that I hate and the reason why I have almost nothing into my RRSP account: I already paid taxes on that money. I don’t want to pay it later again.

I list below everything I think is wrong with RRSPs (some are a big issue, some are not):

1 – The tax bracket you are in at the time of the contribution defines how much you get back as a tax break from the government. Check this very good example in the Financial Post to understand how it works. My problem here is that tax brackets change over the years (the last Liberal budget of  March 2016 is an example). If you are in a lower income bracket RRSPs are not that attractive. And if you do not contribute the tax break difference back into your RRSP you are effectively missing out the only advantage RRSPs offer.

2 – Your money is trapped there! Once you make contributions into your RRSP, you can kiss the money goodbye until it is time for you to take it out in the far future. If you want to take the money earlier you will have to pay taxes on that money based on your current bracket (which could be higher than the one at the time of contribution), making the overall return of your investments smaller. If you need the money for an emergency or if you change your mind because of a life changing event, you are out of luck.

3 – RRSP advocates assume your investments growth will compensate the taxes at time of withdrawals (plus inflation, etc). And that is a BIG mistake. Here in the province of Alberta, the lowest combined (provincial and federal) taxes you pay is 25% (10% and 15% respectively as of March 2016) for people making less than $45,282.00. That means if you withdraw at most this amount, you are going to pay at least $7,754.00 a year in taxes (thank you taxtips.ca). So your investments hopefully were successful to compensate for more than $7,000/year just in taxes (plus inflation…). But remember, all this assumes you became low income. If not, if for any reason you got more successful later in life (I know a few cases like that), than I am sorry but you are now paying more in taxes than you should be, on the same money you already paid taxes on.

4 – Reason 3 is bad but Reason 4 is even worse than 3 because withdrawals are COMPULSORY after age 71. That is right. It doesn’t matter if you want your money or not right now, you have to make withdrawals when the government tells you to. I am 40 years old now. By age 71 people will have a 90+ life expectancy (hopefully). That is 19 years of withdrawals to add to my regular yearly income that will be taxed.

5 – And to make things worse, in Canada you are eligible for Old Age Security Pension benefits if you make less than $119,398.00 (per individual, as of April 2016). That is another $570.52 you get from the government that will be used to calculate you income for the year. Income, not dividends, not capital gains, nor anything else that has a lower tax bracket. It is income. So now you have to be careful to not jump to the next tax bracket otherwise your returns on RRSP will look even smaller.

If you already contribute to your RRSP and know that you will be in a lower tax bracket later in life than it might be the solution for you. I would personally make contributions to both if that was the case. I am assuming you have enough cash at hand to do both. Some people use part of their RRSP tax break to put the money into their TFSA to max it out, which is another good alternative.

TFSAs, on the other hand, have many benefits. You cannot claim losses but you don’t claim any gains either. You can take the money out anytime, tax free, and your contribution limit does not change by doing that nor the contribution limit is affected by your income. It is fixed and easily calculated. You have access to the same investment options you have for RRSPs but the interest on those investments can be taken at face value. You know exactly how much you made since there are no future taxes to calculate. You can even get cash from dividend paying stocks or ETFs tax free which is even better than the already lower dividend taxes.

TFSA contribution limits keep increasing and will eventually bridge the gap with RRSPs and surpass it (although the last Liberal Government changes slowed the process down quite a bit back to $5,500/year from $10,000/year). And last, but not least, if you know what you are doing, you can make tons of money without paying a dime to the government (and pissing them off at the same time) like this investor from Calgary.

If you are not convinced yet check out this article (especially the very end of it). Here you see that there is no real difference between your RRSP and TFSA on the nominal amount you get in the end (assuming an individual’s marginal tax rate in unchanged over time). But your TFSA is much less of a headache to manage later and it gives you much more flexibility (and liquidity) than your RRSP.