Scenario 1: Lump Sum from Loan
Borrow $5,000 (with a $100 fee) and contribute $5,000 in one lump sum to your RRSP. Repay the loan at $637.50 over the next eight months (assuming the fee is added to the loan amount and not paid up-front).
Total contribution to RRSP: $5,000.
Total cost to you: $5,100.
Scenario 2: Monthly Contributions
Over the course of eight months, contribute $625/month to your RRSP.
Total contribution to RRSP: $5,000.
Total cost to you: $5,000.
Comparison
At first glance, at the end of eight months you will be in the same position regarding the RRSP (savings increased by $5,000) but the first scenario will have cost an extra $100 to get there.
However, assuming your investments in the RRSP are rising in value over the eight months in question, then in the first case you would have had all the $5,000 benefiting from the rise in value from day one. In the second case, because you are paying monthly – and only hit $5,000 in the last month – the gains you make will be roughly equivalent to having only had $2,500 invested from day one.
If your investments were to grow at 8% per year, then – by my rough calculations – the first scenario should net a gain of around $266, whereas the second would gain $133. This would be an overall benefit of $133, slightly beating the $100 extra it cost to take out the loan.
Conversely, if your investments were to fall over those eight months, you would be slightly better off with monthly contributions (the $625 in the final months will buy more "units" because their price has fallen and – assuming values rise in the future – you will be better off).
So: you have to decide what are the chances of the stock market rising over the eight months concerned? Does the (modest, in most cases) potential extra gain outweigh the risk that "something happens" and you have difficulty in repaying the loan and possibly incurring interest charges? What are the chances that your investment will lose value, and make the lump-sum option worse?
