Retirement funding — big buy or diversify?

Resist the urge to put all your retirement eggs in one basket.

In my book Enough Bull, I looked at alternatives to RRSPs for financing your retirement. There are various options: TFSAs, buying equities in a non-registered investment account (to preserve the 50% capital gains inclusion rate that you give up in RRSPs), retaining profits in a corporation for later dividend distribution, and real estate. Since this is the real estate issue, let’s revisit the last one.

A logical argument could be made that real estate may be a better vehicle than the typical recommendation to use equities in an RRSP to fund your retirement. This is especially true if the real estate is the place you live and is therefore eligible for the principal-residence exemption. Here’s the idea: buy as big a house as you can afford using all your savings, including any money you would otherwise have contributed to your RRSP. Borrow as much as the bank will lend you. Watch your property increase in value over your lifetime and, when it comes time to retire, sell it tax free and buy a smaller property. Finance your golden years with the net tax-free funds and your CPP and OAS.

What do you think? Does the strategy make sense? I would argue that it may make sense on paper, but in reality, it is a strategy you should avoid. Here are some reasons why:

•  Increased costs  While your big house may look impressive on your net worth statement, think about the cash flow implications. Almost everything will cost more than living in a smaller house. Think about the mortgage, property taxes, utilities including heat, hydro and insurance, etc. And what about repairs and maintenance? You’ve got a much bigger roof to repair. The furnace and air conditioner will be larger and more expensive to replace. You’ll also have more rooms to furnish. And the list goes on.

•  Keeping up with the Joneses  If you choose to buy an expensive house, the question is where? Most likely it is in a high-status neighbourhood, which will cost more to live in. In their excellent book, The Millionaire Next Door, Thomas J. Stanley and William D. Danko make the statement, “It’s easier to accumulate wealth if you don’t live in a high-status neighborhood.” That’s because in addition to the increased costs already discussed, you might feel the pressure to keep up with the Joneses. You may want to have the right luxury car in the driveway, the landscaping will have to be done by a professional and you will most likely end up hiring a gardener to keep the outside looking sharp. There will also be the lure of the dreaded renovations. There will be more rooms to update, they will be bigger and of course you will want them to look as good, if not better, than your neighbour’s rooms across the street.

•  Interest rate risk  The Bank of Canada increased the overnight rate by 0.25% in July and September of this year, resulting in a corresponding increase in the banks’ prime rate to 3.2% from 2.7%. What if interest rates continue to rise? Your mortgage costs could rise, possibly significantly. For example, a $400,000 mortgage at an annual interest rate of 4% amortized over 25 years costs $2,104.08 per month. If the interest rate increases by just 1% to 5%, the monthly payment increases to $2,326.42, an increase of $222.34, or 10.6%. That’s an increase to your cash outflow of $2,668.08 a year. If the rate increases to 7%, the monthly payment goes up to $2,801.66, an increase of $697.58 a month, or $8,370.96 a year.

•  Liquidity Even if interest rates are kind and you are able to handle the costs of maintaining the property, what happens when it comes time to cash out and you can’t find a buyer for your property? There could be any number of reasons for this. For example, with the millennial generation finding it difficult to secure full-time employment and artificial intelligence replacing humans in increasingly sophisticated functions, where are millennials going to get the money to afford your monster home? What if the government changes the rules? For example, the Ontario government recently brought in a 15% non-resident speculation tax in the Greater Golden Horseshoe Region that contributed to a significant slowdown and resulting price drop in home sales.

In conclusion, resist the urge to put all your retirement eggs in one basket. Sure, buy a house, but make sure it’s one you can afford. That will free up the cash to invest in your RRSP to help fund your retirement. It’s consistent with the best financial advice there is — diversify your wealth, because no one knows what’s going to happen next.