You Can't Not Invest

With the conclusion of RRSP season on the way, there is a lot of information and misinformation floating about in advertising and in the media. The big question is about whether to invest or use the money to pay debts or for some other purpose. The thing is, there is a false dichotomy pervading the discussion. No matter what you choose to do, or not, with every dollar, is an investment activity. I wonder how the government's attempt to increase financial literacy will deal with this.

Take the simplest case: there is cash in your pocket and you decide to keep it there. First, if you can avoid the temptation to spend it on something transitory -- with no enduring or resale value, like a Sens ticket -- the value of the money is continually in flux. Even if your intent is to spend the money on goods or services, the price of those goods and services will change. Manufactured goods that are imported will at the very least change with the loonie's exchange rate; domestic goods with foreign inputs will similarly see price shifts. If you think our dollar will increase in value, parking the cash while you delay your purchase is a form of investment.

The other big impact on cash is inflation. Since cash is completely unshielded from inflation, as the dollar declines in value all cash move downward an equal amount. The effect today is mild but that is not assured to continue for long. Unfortunately and for the same reason, putting the money is a chequing or savings account is no better since the interest rate you earn may be zero or negligible.

That's about all you can do with cash, if your objective is to hold on to the high liquidity of the wealth that cash represents. There are other ways to invest cash without losing a lot of liquidity, such as GICs and T-bills, but there is the friction of buying and selling, and there may be transaction costs associated with early withdrawals. This will be a common theme in cash investments, that higher interest rates are offered if you cede some or all control over those funds for a period of time. Like anything in life, there's no free lunch: if you want more, you have to give more, even if the 'more' is an intangible item.

The above investments, or any investment vehicle, can be done on a cash basis or as part of a government-recognized plan that has certain tax implications. This is where RRSPs and other programs enter the scene. These programs are neither better nor worse than cash investments, just different. Assessing those differences is key to deciding if they are beneficial to each individual. All I can say about this if you are unclear on how to decide whether to invest via one of these programs is to suggest that you visit a professional financial planner.

Then there's the debt option, where you use that cash to reduce the principle and, in consequence, future interest charges. In general, the interest on debt is always higher than savings. This is no surprise since this is how banks base much of their business: the charge more on the money they lend than they pay on the money they borrow (from you!) to cover operating costs, risk (some proportion of loans go bad) and profit for shareholders. If you are both a saver (e.g. RRSP) and a debtor (e.g. mortgage) you can only win at this game when the interest rate is changing rapidly, and in your favour. I think that it is arguable that no consumer should attempt this game. In any case it's pointless now since interest rates are static and likely to remain so for a time.

The usual argument for choosing between paying off debt and investing in an RRSP is if you can accurately forecast the long-term wealth differential between the two. This can be very difficult. Many assumptions must be made, which include but are not limited to: job and income security, inflation, comparison of current and future tax brackets and rates, investment risk, likelihood of family tragedies, and so on. For example, while it's true that if you use the cash to reduce a mortgage there can be a large difference in the long-run cost of the mortgage, if there is any chance that you might need that cash in the not too distant future, you will either have to renegotiate the mortgage or take out a loan: both can be financially injurious. That's just one example of a difficult investment decision and, make no mistake, it is an investment decision: you are deciding where to place a portion of your total wealth to best serve your future needs, or, more simply, to achieve the largest possible future return on that wealth.

Non-cash investments are most often found in the stock market. When you buy a share in a company, whether directly or via a mutual fund, you become a part-owner of that company and subject to the same risks and potential returns of any business owner. That risk, which is rarely quantified with any accuracy or under your control, is inseparable from returns that can be very high in comparison to predictable returns of cash instruments. Even if you choose mutual funds -- as most do, especially for RRSPs -- equity investing requires a strong stomach and a firm hand. Every day you should be asking what a stock, fund manager or financial advisor has done for you today. Be ruthless about it; loyalty to a company or a manager is folly. It's your money and your future at stake.

Of course you can always live for today and spend the cash in your pocket, and let tomorrow take care of itself. This is not necessarily a bad thing if it fits with your lifestyle, provided that you don't rue tomorrow what you did yesterday, or if you have dependants. Hedonism and allowing oneself to be blown about by the winds of change are investment strategies that do work for some people. Even pessimists can benefit by this if they truly believe that disasters that await us in the future will render any investment worthless. If this philosophy works for you, reading blog posts about investing is a waste of time: get out there and have some fun with your money.