Author: Mike Holman

We recently received a question from a reader whose name is Samantha. Samantha asked about the benefits of contributing to a RRSPs (401k for our American readers) for younger investors under the age of 30 who have other debts. My first reaction was – how would I know? It’s been almost a decade since I turned 30, but then I calmed down and looked at her situation and came up with a few suggestions. In addition to my own suggestions I contacted Preet Banerjee of WhereDoesAllMyMoneyGo.com who is much more knowledgeable than myself in these matters, to get his opinion as well. You can think of it like a Pros vs. Joes match! 🙂 A big thanks to Preet for helping out with this one.  If you are wondering when the rrsp contribution deadline is then check out my RRSP  deadline page.

First let’s take a look at her situation:

Samantha is 25, married with a steady job.

Debts

Mortgage – $212,000

OSAP (student loan) = $28,000 at 8% – minimum payment is $309 per month.

Income

Samantha makes $34,500 and her husband makes $49,000.

Other facts

She has an employee match of 100% for up to 3% of her salary in a group rrsp. Currently her rrsp is about $300 (hey, she’s young!).
Samantha basically asked two questions

1. Should she focus more on debt rather than rrsp? Since she is young she has lots of time to contribute to the rrsp later.
2. Should she contribute to the rrsp to get the employer match?

The first question is the old “debt vs investment” question which I won’t get too far into since the answer is that in a lot of cases it doesn’t really matter where you put your money since both rrsp and debt reduction are very positive actions. Her student loan does have a higher interest rate (8%) but since student loan interest is tax deductible in Canada, the effective interest rate should not be excessive. It’s possible that the rrsp will outperform the interest rate of the loans but since we can’t predict the future, there is no point in guessing.

A couple of exceptions to the previous statement are:

• If you have excessive debt where the payments are crushing your lifestyle then perhaps the debt repayment should get priority.
• If you have very little savings then you might want to contribute more to an rrsp since it can act as a safety blanket if times get tough.

What Preet said:

At $34,500 her marginal rate is 21.05% in Ontario which means her after-tax interest cost on the student loan is 6.32%. If cash-flow is tight (normally the case at that age), then they could consider shopping for new financing on the loan for less than 6.32% with a similar (or shorter term), or for more flexibility they could even pull that into the mortgage (you’d have to check to see the costs for doing so, namely if you have to pay a top-up premium for CMHC premiums). If the mortgage rate is under 6.32% they would free up a fair bit of cashflow. It is important to note that the debt now becomes longer term, so if considering this you would want to make sure the savings are re-directed into something beneficial (mortgage top-up payments, savings, etc.).

If the husband is not maximizing his RRSP contributions, they would yield an extra 10% for spousal RRSP contribution refunds if he makes them to her spousal RRSP account as his marginal tax rate is 31% versus her 21%.

If they do end up consolidating debts, the extra cashflow (perhaps $150 to $200/month) could additionally be used for further RRSP contributions with the refunds going to accelerating the mortgage (or paying down vehicle loans, credit card balances etc.).

Employee match

The question of contributing to an rrsp with an employee match is a no brainer – there are very few circumstances where you should not be contributing to an rrsp with an employer match. To do so is leaving money on the table, so if nothing else – contribute enough to get the match.

What Preet said:

I would most certainly take advantage of the matching – that is free money! Don’t even think about it, just do it.

Summary

Both Preet and I agree that utilizing the 3% employer match on her rrsp should be a top priority.

After that she can split her extra money on debt repayment and rrsps. The exact proportion will be up to Samantha, but considering that her rrsp is very small, she might consider giving more money to the rrsp at first in order to build up a bit of a safety net. Preet made a great suggestion that the husband should be making the extra rrsp contributions into a spousal rrsp since he is in a higher tax bracket. In other words Samantha should make the 3% contribution to get the employer match and then after that, any contributions will go into the spousal rrsp account.

Preet also came up with the suggestion of consolidating their loans which might free up cash flow to further paydown debt.

Anybody else want to add to this?

Please note that I am not a financial advisor so it’s important to do your own due diligence (sorry Mr. Cheap).

Feel free to check out Preet’s personal finance blog.

Last week, (ironically on April 1) Questrade discount brokerage announced a change to their trading price structure. The new trading costs are 1 cent per share with a $4.95 minimum and $9.95 maximum.

I don’t understand

Ok, here are some sample trading costs:

• If you trade 70 shares then you pay the minimum $4.95
• If you trade 700 shares they you pay $7.00
• If you do a trade for 7000 shares (yah right!) then you pay the $9.95 maximum.

How is this different than the old price structure?

Well the old structure was more complicated in that you could choose between two different plans.

The $4.95 plan:

• 1 cent per share with a $4.95 minimum and no maximum cost.

The $9.95 plan:

• 1 cent per share with a $9.95 minimum and $9.95 maximum.

The $4.95 plan was better if your average trade was 1000 shares or less and the $9.95 plan was better if you average more than 1000 shares per trade.

Why did Questrade make this change?

If you have read this far, you are probably saying “Mike, I didn’t know what their old pricing was, I really don’t care what the new pricing is, so when is this post going to get interesting?”. Answer = right now! (relatively speaking of course).

My theory on why Questrade changed their pricing structure is that it will save them money – pure and simple.

How does it save them $$?

• The old structure was somewhat confusing, which probably resulted in a lot of calls to their customer service which cost money.
• They would have to have systems functionality to handle the two different structures which also costs money.

I suspect that the only investors who would choose the old higher priced option (you need to do 1000+ share trades to make it worthwhile) would be high rollers who do big dollar trades or penny stock investors (since you don’t need a lot of money to buy 1000 shares of a penny stock). The high rollers are probably doing their investing with the big banks since they would get limo rides to their broker’s parties. The penny stock investors are not all that numerous. The fact is that Questrade probably did not have very many clients choosing the $9.95 option so eliminating the option probably does not lower their revenue significantly.

The only investors who will really benefit is some way will be ones who move RRSPs to Questrade and make large initial purchase trades, but then much smaller subsequent trades. When I moved my RRSP, I used the $4.95 plan and paid over $10 per trade on a couple of transactions, so if this policy had been in place at that time, I might have saved about $4.00 in trading costs. I knew I should have waited! 🙂

Summary

This pricing change is fairly insignificant because they already have the cheapest pricing by far in the Canadian discount brokerage industry, and it doesn’t change the trading costs significantly for the average investor. I think the biggest benefit to this move is less complexity for the investor which is always a good thing.

Click here to open an account with Questrade

Some other posts I’ve written about Questrade:

• Questrade Discount Brokerage Offers US Dollars In RRSPs
• Questrade Referral Promotion
• Why I’m sticking with Questrade

Lending Club, the popular peer-to-peer lending site sent out an email this week to members basically saying that they are ceasing to accept any new loans indefinitely. In the email they mention they are filing with the SEC to be able to create a secondary market for their loans, but there isn’t any mention of why they can’t keep accepting new money.

I find this is extremely suspicious behaviour. What kind of company stops selling their product while a new one is being developed?

Over at TechCrunch, there is speculation that Lending Club needs to get a broker-dealer license from the SEC to legitimize its operations. If true then it’s very possible that Lending Club will be back in business, but it doesn’t say much for the company if they didn’t get this license before they started.

Obviously I didn’t anticipate that Lending Club would run into financial trouble but in a post I did recently, I raised a concern about their marketing costs:

Another issue I have is that Prosper and Lending Club seem to be spending a lot of money to get clients – advertising, free money giveaways. Where does this money come from?

Speculation alert!

I think that Lending Club is finished. While it’s possible they can come back from the dead, I suspect they will just sell their portfolio of loans to another company and that will be it.

[edit  – looks like I was wrong!  Lending Club is alive and well]

 Other resources

• Lending Club – Why I Chose Not To Invest In Peer-To-Peer Lending

• Investment Recommendations for Friends,
• Canadian Peer-to-Peer Lending
• Is Lending Club Bankrupt?

photo by wwworks

Vanguard just announced that they will be offering a global stock index fund and global stock exchange traded fund (ETF) in the second quarter of 2008.

They will track the FTSE All-World Index which measures the performance of large- and mid-cap stocks worldwide according to their market capitalization weighting.

The fund will be approximately 45% U.S. securities and 55% non-U.S securities.

Global Stock Index fund and Global Stock ETF fees

The fees are 0.45% for the index fund (available to American investors only) and 0.25% for the ETF which is available to Canadians through your discount broker. I think the ETF fee of 0.25% is a bit high considering that you can buy the American stock ETF with a mer of 0.07% and VEU which is Europe and Asia – mer is 0.25%. If you were to buy those two ETFs for your portfolio – let’s say 50/50 then the mer would be 0.16% plus extra trading fees. The new ETF is definitely more convenient however.

No small cap

One of the drawbacks of this index is that it only includes mid-cap and large-cap companies so there is no representation of small cap companies. According to the FTSE site, this setup encompasses 98% of the world capitalization so you could make a pretty good argument that the small cap companies don’t matter. A lot of investors such as William Bernstein (author of the Four Pillars of Investing) himself believe that small caps will outperform larger companies mainly because they have a higher risk profile and have done so in the past. Personally I’m skeptical because the “small cap will outperform” thing has been so well documented that I don’t believe they still have an advantage.

Home country bias

It’s been well documented that most passive investors will over-weight their home country when planning their equity asset allocation. There are a lot of reasons – familiarity, currency risk are perfectly valid reasons for having more familiar equities in your portfolio. For Americans, those reasons are not all that valid because their equities make up such a large part of the all-world index that they can diversify abroad and have their home-cooked equities as well. Canadians and other small countries can’t do this – in the case of Canada, the market capitalization share is only 3% so to have the proper weighting, a Canadian would have to have almost no equities in their home currency which might not be a great idea for someone who is in retirement and wants to maintain a high percentage of equities. As I discussed, the Canadian index is not just small, it’s not very diversified either which is a common situation for smaller countries.

Should you buy the new global stock ETF?

I think if you are a passive investor and want to cut down on the number of securities that you own then this ETF is worth looking at. Unfortunately, a lot of investors will probably want to buy at least one more ETF to add small cap companies and to increase their home country investing.