This week, we are returning to questions from one of our readers: Stéphane.
“My RRSPs and TFSAs are now “full”, and I estimate surpluses available for savings of $10,000 to $20,000 (for 5-10 years). Also, I have $50,000 “sleeping” in a bank account, and I’m torn between investing it in my investment portfolio and buying a GIC (there seems to be one at 3.25% for five years) .
It is still 20% five years later. Do I have to pay tax on GIC returns? I think not, but if so, I guess wealth management is still the best idea, or should I speed up the mortgage repayment? »
Whether or not to use GICs
Let’s answer our reader’s question first: Guaranteed investment certificates (GICs) are the safest way to invest money. The investor lends his money to the financial institution in exchange for a guaranteed rate at maturity. An important clarification, therefore, is that the rate of 3.25% noted by Stéphane for the five-year product is the rate at the end of the term.
In reality, it is a rate compounded annually which is not even close to 1%!
Generally, the longer the term, the more interesting the rate offered. Our reader should keep in mind that this type of product is not liquid, because even with redeemable products, the saver must generally pay a certain amount to access the capital before the end of the term.
Moreover, in the context of the expected rise in interest rates, a five-year term seems very long to me.
Thus, GICs should more than ever be reserved for short-term savings and investors with a very low tolerance for risk. If Stephane was considering GICs to hedge against current market volatility, my answer would be quite different. Indeed, during periods of volatility, investors tend to want to favor the preservation of capital.
It must be remembered, however, that the peace of mind that our reader will obtain with the GIC carries a major opportunity cost. Indeed, in the long term, there is a much greater chance that a quality fixed income portfolio will generate more returns than guaranteed products.
Stéphane should therefore favor investing in the markets if his investment horizon is long term.
Regarding the taxation of GICs, you should know that they generate interest income. Since our reader mentions that he no longer has unused contribution room for his RRSPs and TFSAs, he should know that this income will be taxable annually according to the anniversary date of the product.
Since the tax treatment of interest income is less advantageous than that of dividend income or capital gains, it is advisable to hold this type of investment in registered accounts in order to optimize the portfolio for tax purposes.
sleeping money
The fact that Stéphane mentions in his message having “$50,000 dormant” in his bank brought a smile to my face, because I myself use this expression very often with clients.
Unlike humans, money does not need to sleep! While it is important to have an emergency fund for contingencies, I often find that people are at odds on this issue: either they don’t have any, or it is too rich.
My advice here would be to limit the emergency fund to an amount corresponding to a maximum of three months of budget expenditure and invest the difference.
Invest or pay off the mortgage?
In order to resolve the dilemma between investing and repaying the mortgage in an accelerated way, it is worth asking yourself a few questions. What is Stéphane’s borrowing rate, versus what rate of return can he expect to obtain with his investments according to his risk tolerance profile?
This comparison must take into account the tax rate of our reader. For example, if the effective rate is 30%, a borrowing rate of 2.5% would be 3.25%, while a non-recorded investment return of 5% is more like 3.5%.
There is no doubt, according to this criterion, that as long as a GIC is purchased, the saver should repay his mortgage loan, especially if the mortgage product makes it possible to re-borrow later from investments and thus convert non-deductible interest in deductible interest.
The presence of a spouse in the portrait could also influence the recommendation, and require that the current repayment schedule be followed to respect each person’s investment autonomy.
Investing outside of RRSPs and TFSAs
As our reader does not have children, the RESP is not a solution for him. However, remember that in the case of a parent with dependent children, maximizing RESPs would be the first step to take here.
Since he already contributes as much as possible to his RRSPs and TFSAs each year, Stéphane will have to optimize his portfolio for tax purposes, as mentioned above.
Finally, since our reader is interested in guaranteed investment products, it is possible to believe that his risk tolerance is not the strongest. The retirement insurance strategy could potentially be explored, if he also has estate planning needs.