The main focus for people fresh out of school should be paying down debt, although investing early for retirement offers substantial tangible benefits even in the short term, financial advisers say.
Jon Hembrey · CBC News
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You've graduated, you're starting your first job and suddenly you have some money left each month after covering the rent, utilities and grocery bill – but what's the smartest thing to do with that cash?
Although a truism in investing is to start early in order to reap the benefits of compound interest over the long term, many financial advisers say that these days a person fresh out of school has to consider other priorities as well.
That does not mean young people should avoid retirement planning altogether. Rather, it means taking a smart, balanced approach to investing and covering off other financial commitments.
Ditch the baggage
Fresh-faced graduates taking up entry-level positions sometimes cannot afford to contribute to an RRSP while still staring down student and credit card debt, for example. And no matter what they studied, debt is one of the main things recent graduates have in common.
'You want to have the least amount of baggage in terms of debts as possible.' —Tina Di Vito, BMO Retirement Institute
Annual tuition rates increased from an average of $1,271 to $5,139 between 1990 and 2010, according to the Canadian Federation of Students. And those annual fees can add up to a daunting sum by graduation—from a national average low of $13,000 in Quebec to more than $28,000 per graduate in the Maritimes.
Many also have credit card bills or other loans that need attention, and prudent planning dictates paying down those with the highest financing costs first, according to financial experts.
"You want to have the least amount of baggage in terms of debts as possible," says Tina Di Vito, head of the BMO Retirement Institute and author of 52 Ways to Wreck Your Retirement.
All debt is not necessarily bad, however, as long as it's managed properly. Those just starting out should consider getting a low-limit credit card to build a credit history, while being mindful to pay their bill at the end of each month so they don't carry a high-interest balance, Di Vito says.
"Be strategic and purposeful in building a very, very good credit history," she adds.
Build an emergency fund
As with any age group, budgeting is absolutely crucial to make sure debt levels are managed and enough money is being put away for a rainy day or retirement.
'Lots of people in their 20s have more short-to-medium term priorities rather than long-term retirement priorities that they should be focusing on.' —John De Goey, Burgeonvest Bick Securities Ltd.
People in their 20s need to pay close attention to where their money is going and to limit non-essential purchases, in much the same way their parents should – something many in both demographic groups fail to do.
John De Goey, vice-president and associate portfolio manager at Burgeonvest Bick Securities Ltd., suggests young people focus on building an emergency fund of a few thousand dollars to cover any large, out-of-the blue expense like a car repair bill.
"Lots of people in their 20s have more short-to-medium term priorities rather than long-term retirement priorities that they should be focusing on," he said, adding that there is time to invest down the road.
It can be difficult to pull money out of an RRSP in an emergency without paying a penalty, so some advisors recommend putting it into a tax-free savings account. Money in a TFSA is easy to get at when needed, but can otherwise be allowed to grow there tax-free until retirement.
Hit the books
This is also an important time to begin building financial knowledge, starting with simple ideas like budgeting before working your way up to purchasing stocks or bonds, says Adrian Mastracci, a portfolio manager with KCM Wealth Management Inc.
Risk-taking youths
With retirement decades away, young people can choose to plan aggressively for the future by taking on riskier equities because over the long-term markets tend to grow, financial experts say.
Even a downturn lasting several years, the assumption goes, will be made up for by the time a person reaches retirement.
However, young people planning to use their investments to purchase a home should be wary because that means they do have short- to medium-term goals. If they are going to need the money relatively soon to put down on a house, a more conservative investing approach is wise – particularly in the current volatile financial market.
Many young people starting their careers have aspirations to purchase a home, and now is the time to save and to get acquainted with the basics of a mortgage before they actually take the plunge, De Goey, author of The Professional Financial Advizor II, says.
For example,under the government’s Home Buyers’ Plan, a person can withdraw as much as $25,000 from their RRSP to buy or build their first home as long as they return the money over a number of years. So saving for a home can go hand-in-hand with retirement planning, and it pays to know what the options are.
There are also numerous websites that offer advice, including getsmarteraboutmoney.ca which is operated by the non-profit Investor Education Fund, as well as a plethora of financial self-help books. One oft-cited introductory text for investing novices is The Wealthy Barber by David Chilton—he has a newly released sequel that outlines more about the basics of a budgeting, savings and investing strategy.
Investing for the long term
For those who have gotten a handle on their debt and saved an emergency fund, starting to put some money into either a registered retirement savings plan or a tax-free savings account is always a good idea.
Investing early allows the money to grow tax free and over the long term can add up to large returns. For instance, a 25-year-old who begins with a $2,000 contribution in an RRSP and adds $2,000 each year will end up with $330,095 by the time they are 65, assuming compound annual growth of six per cent. A person who starts at 35 and follows the same plan will end up with just $169,603 by the time they reach 65, mainly because the nest egg has less time to grown through compound interest.
The main thing that Mastracci says most young people have to realize isthat they are at the very beginning of their financial lives. "Keep the things simple," he says. "It’s a marathon not a sprint."
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