The Unlikely Retirement Savings Strategy

Prepaying-your-mortgageOne of the best risk-adjusted investments you can make requires no commissions, no buying and selling and no management fees.

According to a new study from the Certified General Accountants Association of Canada (CGAAC), the boring old mortgage prepayment performs better than most common retirement savings vehicles, including RRSPs.

“…Single individuals and couples with no dependents may be better off accelerating their mortgage payments than contributing to a retirement account,” finds the study. “This is the case for all income levels and savings rates, but particularly for lower-income individuals.”

“Those earning $30,000 annually and saving 2% of their earnings will get a nearly twice higher return by accelerating their mortgage payments compared with saving through a RRSP.”

Investment-returnsOnce the mortgage is paid off, it’s assumed that one then takes the money formerly allocated to mortgage payments and starts investing it.

There is an exception to the above findings, however, and it applies to better-off homeowners with kids. The CGAAC says: “…In the environment of relatively low mortgage interest rates, savings through a RRSP may generate a higher return for the higher-income couple with dependents than saving through accelerated mortgage payments.”

In addition, relative performance depends on your investment alternatives. Some folks have access to investments yielding more (after tax and inflation) than  a mortgage prepayment. In that case, speeding up your mortgage burning party may not be your best option.

Exceptions aside, mortgage prepayments entail no principal risk and involve little effort. That makes them one of the best “lazy-man’s” saving strategies one can find.

CGAStudy Particulars: CGAAC’s conclusions are based on an extensive simulation, details of which are in this report. CGAACs core assumptions are on page 16. For mortgages, the study assumes consecutive 5-year fixed mortgages with a 30-year amortization and monthly payments.

Rob McLister, CMT

  1. Interesting post.
    The way I look at it – you just can’t go wrong by paying down your mortgage.
    Even if it’s not always the optimum strategy, it’s still a good strategy!

  2. The problem with this report it is not complete. Since they are talking risk,and returns they can’t or overlook or omit, getting disabled or not having enough coverage to protect the family (even if single) is missed.
    With many people changing jobs, often group coverage is poor or non-existent. The key is to have coverage now before pre-payment on mortgage or RRSP contributions etc.
    Rob, if you have numbers, it would interesting if you can find out how many people get in financial trouble because of a disability or illness who have a mortgage and little or no coverage. My thinking is the numbers maybe low, but people never recover financially.

  3. What does this mean, “Some folks have access to investments yielding more (after tax and inflation) than a mortgage prepayment.” What kind of investments is he talking about? Why do only some people have access to them?

  4. Because people making more than 30K/yr can afford to pay someone to invest their money for them. Not always the case, but that’s what I think they are assuming.

  5. In the financial times we live in… what investment can 100% GUARANTEE me $1800 – $3000/month return…FOR LIFE… Not having a mortgage payment does… I bought my home 5 years ago. Buy prepaying $125 a week, (and moving from 6% fixed to Prime -.6% Variable) my amortization went from 30 years to ….. 8… Can you imagine the freedome of not paying that every month… I can go into semi-retirement @ 45 years old… if I want. Job cuts… no problem… I’ll get a job @ Tim Hortons or Costco… and for couples with kids.. when you move into the old age home and the kids sell the house… they’ll get a 400K lump … what RRSP can do that? NONE.

  6. when you move into the old age home and the kids sell the house… they’ll get a 400K lump
    What makes you think you will automatically get the 400k lump? Housing is extrememly illiquid, and does not always go up in value, as matter of fact if it decreases as we have seen in most markets in world, you are in trouble.

  7. … and how do you plan to pay the $3000/month old age home plus all the other expenses that come with ageing.

  8. Brian are you an insurance salesperson? Insurance is optional. Investing for retirement is mandatory. I think it’s kind of silly to refute these findings because they don’t factor in insurance. Just my opinion.

  9. In Ontario especially, to invest in higher returning hedge funds and private investments you must be an accredited investor. An A.I. has a high net worth, high income, or invests a large sum of money (I think min. 150k) into each investment. Most of the managers of these investments are paid based on their performance in contrast to the mutual fund managers and salespeople who take their cut regardless of whether they lose you money.

  10. If you quit your job at 45 and take a pay cut to work @ timmies then you wouldn’t actually be realizing that extra 1800-3000 p.m. savings on top of your other personal expenses. Therefore, your ROI in that scenario would be the freedom of early semi-retirement. Saving money by paying of your mortgage early or cutting expenses should only be considered an investment when it increases your net worth, which in the case of working at timmies, it would not.

  11. I was once convinced that wealthier people have access to more opportunity based on their scale than the rest of us. Then I woke up and realized that with some research and a willingness to actually take investment matters into your own hands, you can do just fine as a DIY investor. It is completely scalable to your own financial situation and all it takes is a minimum of $1K and some time to open an account with a discount broker (ie. Questrade). Sure you may not be able to afford any Berkshire Hathaway Class A shares, but you can find plenty of worthwhile yielding opportunities in a number of different industries. Heck even HOMEQ Corporation that has been the subject of a few different articles on this very forum has dividends that pay an annual rate of 4.42%, based on today’s share price. IMO, the real issue is whether a person wants to be a ‘lazy-man’ or not.

  12. It is true that the wealthy don’t play around too much in the mutual fund market, the cost for underperformance is shocking. Many use SMA’s and UMA’s, ETFs, Hedge funds, and individual stocks, and fee based accounts.
    I could go on about the advantages. There was a recent article on why people are starting to leave their bank branch mutual fund reps…..too much pressure from their ‘advisor’ to push product and make to meet goals for Visas, creditor insurance, multiple products per client, rather than doing what is in the clients best interest… Fiduciary duty??
    Take a regular mutual fund, say you pay a 2% MER, the guy with $1000 this is perfect. He pays $20 a year for investment management. With a $100,000 your paying $2000 a year and you maybe get 1-2 hours of time from your bank branch advisor… thats $1000-2000/hr your are paying them. $1,000,000 you are paying $20,000 a year.
    With fee based accounts, your cost to invest goes down at different asset levels. ALso your cost per hour for investment advice is lower and most fee based advisors have access to other investments rather than a single mutual fund company.
    What I say to prospective clients is, give me 15 minutes of your time and I guarantee I can improve your situation, I haven’t been proven wrong yet.

  13. What factors would make this less optimal for couples with higher incomes and kids do you suppose? What is a higher income? Related to educations savings?

  14. You’re comparing apples to oranges. Sure there are DIY investors and self-taught day traders who can achieve higher returns than might otherwise be available based on their income bracket. But I believe the point was on passive investing (i.e. not making it your full time job) and there is no question that wealthy people can work with their choice of many highly talented brokers and money managers who have access to markets and investments not available to Questrade clients.

  15. I took it to mean that lower income couples without children have: 1) lower access to investments which would perform better than their mortgage rate, 2) a lower tolerance to withstand the risk of investment losses (paying mtg is risk free), 3) they have smaller amounts to invest, suggesting that investing fees would eat up a bigger chunk of their capital than those with higer incomes (no fees to pp mtg). Finally, while having a paid off house would be fantastic, it wouldn’t directly help your kids with education costs (without heloc), so families with kids should use RESPs if they wish to help them out.

  16. WOW! as you all have just demonstrated there are different strokes for different folks. There may not be just one plan that fits all, get a professional mortgage broker and financial planner on your team.

  17. Brian
    I am personally one of those impacted by an illness (my wife recently died of cancer) without insurance coverage. She was largely uninsurable her entire adult life, and in the year before her death, our income was slashed to 16% of the year before. It has not yet recovered fully since her death, but it may never reach that level.
    I have used the recommendation suggested by the CGAs throughout my entire life i.e. pay off your mortgage first. It was that strategy that allowed me to

      keep the house during her illness, spend as much as I could with her and
      re-leverage the property as part of my recovery strategy.

    Since there is no tax advantage to Camadians vis-a-vie mortgage interest deductions, the best use of your money in any situation is to pay off your mortgage. Once the house is protected, go ahead and invest in the stock market all you want – you’ve earned the right to gamble a little.
    Now I’m not suggesting insurance is not necessary, but the best insurance is not to need it.

  18. These comments drifted off – the article was meant to explain the benefit of paying off your mortgage sooner, rather than investig some of the money while carying a mortgage. I agree 100% that that’s the way to do it. Do all the math you want to prove otherwise, the fact is if you completely ignore investments in mutual funds or stocks, or any kind of RRSP contributions, you are guaranteed at least some profit by making accelerated payments on your mortgage. Yes, yes, yes, stocks ‘might’ earn you a bit more, but the fact I don’t have them means a lot to my sanity. And no hours wasted on investment research. All you do log onto bank website and make an extra mortgage payment when you have cash to do it. And if you think that an RRSP is good – think again!!! You are not paying tax on money you put into it right now – but when the time comes to take it out of that “sweet” RRSP account woul’ll pay possibly even more than you would have at the time of contribution. Not even to mention that due to that RRSP withdrawal that counts as income you’ll be penalized by government by having other payments clawed back (old age security, income suplement and so on).
    If you realy have cash burning holes in your pocket and no mortgage invest in land or real estate since if you sell that for a profit it won’t affect your income.
    If you don’t believe me ask someone who is retired and has RRSP if they would ever start one if they knew then what they know now?
    Remember, they key is to retire with no reportable income so you can qualify for all government programs available, and paying off your mortgage as soon as possible and not getting sucked in to ‘investments’ is a ticket to do it.
    I might sound blant in my statements, but it is what I hear from coleagues and regular folks I talk to.

  19. Dave, speaking from experience, RESP is definitely not something you ‘should’ have for your kids education. Again, as the article tried to explain, if you have a mortgage pay it off as soon as you can and don’t invest in anything else until mortgage is payed off. That ‘anything else’ also involves RESP.
    I got sucked into starting one for both of my kids (young, no knowledge at the time). And now when I’m taking that money out with a mediocre profit kids have to report it as income which affected their qualification criteria for OSAP. If you don’t qualify for OSAP then automaticaly you don’t qualify for many other asistance programs offered at the University. And we had to pay fees to the RESP administrator company (CEFI) and they made a nice profit all these 18 years using our money.They even changed rules mid way costing us even more of our profit.
    If I put that money instead into my mortgage it would have been paid off already, kids would get OSAP (interest free loan from government during scholl) and they would qualify for more tuition grants as well.
    Lesson learned, now I try to let friends know so they can make an educated decision by learning from someone who’s been there and done that.
    Yes, everyone’s situation is different, but why count individual beans when you can just simplify it and leave life without sleeples nights – as long as you cary a mortgage do NOT put your money into any other investments (including RRSP, RESP).

  20. If you are paying off your mortgage in accelerated way bank will give you better rate than a broker. And as I said forget about a financial planner – do NOT invest in anything else but your mortgage. It is a guaranteed profit regardless of the rate at the time. Forget about market ups and downs, rebalancing your portfolio and so on. Only people making money are brokers and insiders who move stuff before you even wake up each morning, and mutual fund managers who charge you MER regardless of if they made you money or if you are loosing it.

  21. What a ridiculous statement. Accelerated mortgage payments have absolutely nothing to do with the interest rate you are given. Nothing whatsoever – regardless of whether you use a bank or a broker.

  22. Don, I meant to say that customers who go with accelerated payments or can make extra payment in some other way on their mortgage are viewed by the bank as preferred customers (meaning – they have money). As such you get a better rate at renewal than some guy who is looking to lower their payment as much as possible.
    It’s always been like that – those who can most afford to pay for something end up getting the bigest discount. I was even told that from my friendly banker (yes, I got the bigest discount possible and didn’t have to ask for it).

  23. Oh God, somebody help Drazen. You need an advisor so bad. The funny thing is you think you’re making the best choice.
    And don’t believe everything you hear….Please do some research or get an advisor quick before its too late and you end up like those colleagues of yours!

  24. Anytime a mortgage or any loan with interest is prepaid is a smart move, and the closer one gets to retirement, the more you need to look into doing so. Not only is it wise to free up money to add to your retirement fund or savings, but with prepayment of mortgage and/or other loans, you are eliminating the payments, period. This gives you a better handle on your overall finances going into retirement, thus allowing you to better plan.

  25. Not as good as 20% may sound since, like I said, it is better to use OSAP during University, and all the extra cash you would have put into RESP is better invested in your mortgage for a better return than 20% over the years.
    And here is the kicker – if your kid does not go into postsecondary school you loose all that 20% government gave you !!! Are you sure your child will attend in 18 years from now? No one knows. Many have lost that contribution.
    So simplify things and play 100% safe by paying off your mortgage only for a “guaranteed” profit. Diversifying into other types of investments at the same time does not pay off as much as people think it does (I know it might for some but the effort required to achieve it is too much for an average person raising a family)

  26. Don’t need an advisor to make mortgage payments pal.
    And I’m not investing in stocks or mutual funds to make brokers (maybe you) rich at the same time, regardles of how those investments perform.
    I’m doing just fine except for that mistake starting RESP that I can’t cancel now, but no big deal.

  27. John-
    Sorry for your loss, and I shared your experience. An uninsurable spouse who when she was diagnosed, we both stopped working to spend as much time together as possible; like you, the income was slashed to 17% of the year before. I also took the year following to realign my goals, and I’m happy to say recovery is well underway.
    Funny its easier this time around!
    Paying down the mortgage was critical to our survival during those two years. It will always be the best strategy – protect the castle, invest in fixed appreciating assets (real estate) then invest that income in the stock market. Works every time – and my coaching clients have always succeeded following that rule!
    There is no investment – stock, bonds, paying down credit card debt – that yields a higher pre tax return with long term benefit than paying off your mortgage early. Imagine paying off tomorrow’s debt with today’s cheap money.

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