Thanks for keeping your financial planning process questions headed my way. In a recent post, we addressed a retirement planning query. Now, we’ll cover this one:
“I’ve got some ‘extra’ cash available. Where or how should I invest it?”
I know, you may be chuckling at the idea of having too much money. ‘What to do with excess cash?” might not seem to be much of a problem. But seriously, even if you’re not as wealthy as Warren Buffett (who just donated the equivalent of $3.6 billion USD to charity), there have probably been times when you’ve had extra cash. Maybe you received an inheritance, sold your business, got a raise, or tucked away some savings beyond your lifestyle reserve. There are three main options for what to do with excess cash:
- Pay down your mortgage principal or other debt
- Contribute to your RRSP or TFSA
- Add it to your taxable (non-registered) investments
How do you prioritize these possibilities? When I’m working with a client through the financial planning process on their issues, we typically start by quantifying these questions:
- What is your current and future expected earned income?
- What are your investments’ expected returns (based on your asset allocation)?
- What are your current and future expected marginal tax rates?
- How many years until retirement (or other major financial milestones)?
- What’s the interest rate on your mortgage?
With clearer numbers to tell you where you stand today, your investment priorities, short and long term financial goals start coming into focus. That said, there are so many variables involved, it may be worth consulting with an independent financial advisor for a financial needs analysis – especially if the dollar amounts are significant.
Another consideration, albeit hard to quantify, is how you feel about having debt. Even if “the numbers” suggest otherwise, if having debt keeps you up at night, this should definitely be factored into your decisions.
Here are a few ideas to get you started.
This one is easy. No ifs, ands, or buts – you should always pay off high-interest consumer debt (such as credit card balances) before investing extra cash.
Paying down your mortgage vs. investing.
If your mortgage interest rate is especially high, it may take top priority. If it’s less than the expected return on your investments, then you may be better off adding the cash to your RRSP or TFSA up to their maximum available room, and to your non-registered accounts after that.
RRSP vs. TFSA.
It’s important to apply tax strategies to your decision about what to do with excess cash. Adding after-tax assets to your TFSA results in future tax-free returns. As such, a TFSA may appeal if your current tax rates are lower than you expect them to be later on – such as if you’re earning $50,000 or less, and/or you’re younger or just starting out. That said, once someone graduates to a higher tax bracket, the extra cash might work double-duty for you in an RRSP. Simple tax strategies suggest that by adding it to your RRSP, you can invest the cash and potentially use the resulting tax refund to pay down debt such as your mortgage.
Paying off your mortgage may not be the “best investment you will ever make”.
Revisiting the psychological aspect again, paying off your mortgage is always satisfying – but it’s not everything. I’ve seen too many families fixate on paying off their mortgage, fast and furious, while allowing their investments to languish. They end up at age 55 or 60 with no mortgage, but no savings either. A balanced approach based on a personalized financial needs analysis may make for happier outcomes.
Business owners wondering what to do with excess cash in the business?
If you’re a business owner with extra cash in an operating or holding company, should you withdraw it, pay the tax, and reinvest it elsewhere … or not? To make a very long story short, it’s almost always financially beneficial to pull the money out and invest it in a TFSA. But there are so many considerations and a few important exceptions; it’s usually worth financial needs analysis first.
Bottom line, besides paying off high-interest debt as quickly as possible, there is no universal solution that works for everyone, every time. That’s a blessing and a curse. Multiple choices complicate things, but they also offer the flexibility to develop a multi-choice strategy that makes the most sense for you.
Regardless, remember this: If your income is higher than your expenses and you need to figure out what to do with excess cash, that’s a great “problem” to have. No matter how you “invest” this extra cash, you’re still better off than if you didn’t have the money to begin with, and well on your ways to achieving your short term and long term financial goals.