Get a handle on your personal finances before playing the market, expert says
Jon Hembrey - CBC News
Posted: February 16, 2012
Although the basic concept of investing – generating income through interest, dividends, or by buying something and then selling it for more than you paid – may be relatively straightforward, many Canadians struggle when it comes to actually figuring out how to make their hard-earned dollars grow.
There is, after all, a plethora of options that runs the gamut of acronyms, from RRSP to TFSA and ETF to GIC, terms that may bewilder the less-financially savvy. Should you purchase equities, bonds, gold or real estate? Where can you safely stash your cash and stay ahead of the financial ravages of inflation?
The investing world is undeniably complicated. However, most financial experts say the basic concepts have changed little over the years and practical investing almost always begins with plain-and-simple budgeting.
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Simply put, you cannot invest if all your money is already spoken for. So get your budget straightened out first and foremost, and work from there.
'People are kind of out of touch with where their money goes.' —Rose Raimondo, financial planner
"A back-to-basics approach is really about spending more attention to managing cash flows," says Rose Raimondo, a financial planner with Calgary-based Raimondo & Associates Ltd.
"More and more, I see people are kind of out of touch with where their money goes," she says, adding that this is true across all demographic groups. It's also an issues for both novice and savvy investors.
That observation would seem to be borne out by information from Statistics Canada. In 2010, the average personal savings rate in Canada was just 4.8 per cent, down from a peak of 20.2 per cent in 1982 (see chart at bottom of page).
Household debt is also at record levels, according to the Vanier Institute of the Family. The average Canadian household owes $100,000 – including a mortgage – and its income-to-debt ratio is around 150 per cent.That means for every $1,000 of after-tax income, the average family owes $1,500.
It's hard to get an investment strategyworking for you when interest payments are taking big bites of your cash flow. Paying down non-deductible debt, including car loans or credit card bills, generally ought to take priority over investing, Raimondo says.
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RRSPs vs. TFSA
Assuming there is cash to go around after paying the bills, one of the most popular investment vehicles remains theregistered retirement savings plan. Savings can grow tax-free inside the plan until they are eventually withdrawn, at which point the money you take out is added to your annual income and taxed.
RRSPs can be built usinga number of different types of investments, includingguaranteed investment certificates(GICs), mutual funds, government and corporate bonds,exchange-traded funds(ETFs), mortgage-backed securities, gold and silver bullion orstocks.
In 2011, Canadians were allowed to contribute up to 18 per cent of their 2010 income to an RRSP, up to a maximum of $22,450. Contribution room, moreover, accumulates each year and person can catch up at any point in time.
There are also programs that allow tax-free withdrawals for the purchase of a first home or to return to school, although the money needs to be returned over a set number of years.
Another option is thetax-free savings account, which started in 2009. Here Canadians can squirrel away $5,000 of after-tax income each and every year in any number of similar investment vehicles and this money, too, will grow tax-free.
Financing post-secondary education
Foryoung families, a registered education savings plan (RESP) is another popular choice. The government provides a 20 per cent top-up grant to a maximum of $500 per child each year and, much like an RRSP or TFSA, money will accumulate tax free. Your child will be taxed when they withdraw the money, but at this point in their lives they will likely get most, if not all, of the money back from Ottawa, since they are unlikely to have a large income while they're going to school. A maximum of $50,000 can be saved in an RESP.
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If there is only money to spare for either a RRSP or a TFSA, those with short- to medium-term goals are usually encouraged to invest in the latter because they can withdraw the money penalty-free if they have a financial emergency. However, a person cannot return the money to the TFSA that same yearwithout paying a penalty if they have already surpassed their maximum contribution limit earlier in the year. They can replace it in the TFSA the following year, though, and any unused contribution room is carried forward to the next year.
Accordingly, a TFSA is popular for those just starting out in their careers because it can act as an emergency fund as well as a retirement fund.
RRSPs, on the other hand, are tax-deductible, which means you get a tax refund on money you put into a registered retirement savings plan. So contributing to an RRSP when you are in a higher tax bracket can be advantageous, because it results in bigger upfront savings.
Risk-tolerance, time horizons
Now that you’ve got a grasp on some investment vehicles are available, it’s time to decide what to actually pump your dollars into.
However, this is ultimately a personal decision that is dependent on number of factors, including whether the money is destined for retirement or the purchase of home, and your general risk tolerance, says Adrian Mastracci, a fee-only portfolio manager and financial planner with Vancouver-based KCM Wealth Management Inc.
If you are a long-term investor, it is generally advisable to go with higher-risk equities in order to generate a higher return, since you can afford to wait out a sudden market downturn, confident that prices will move upward at some point.
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Bonds or GICS, on the other hand, are a better fit for someone who is less risk-averse or someone who knows they'll likley need to access to the money in a few years for a major purchase. The return tends to be lower, but the investment is more secure.
Choosing an adviser
Need help choosing the right financial adviser? CBC Newsoffers some tipson finding someone to help guide your finance plans.
For most people, making these decisions involves getting some input from a professional. This is especially true for those who are10 to 15 years away from retirement.
"The world of finance needs a fair degree of smarts in a lot of areas," including investment knowledge, tax laws and the ability to generate long-term projections, Mastracci says. "If you don’t have those skills, then you need to find somebody who does."
Investing early
One of the most basic rules in investing is that starting early yields big returns through the power of compound interest.
For instance, suppose a person wants to invest with the goal of having $500,000 for their retirement. Assuming an annual growth rate of six per cent, a person who starts at age 25 would need to save roughly $3,231 a year to reach that target. If they start at age 35, they need to put away $6,324 annually. At age 45, they need to save $13,592 a year to reach $500,000.
Investing early, say in your 20s, also lets you get a grasp on how the whole process works before attempting more complex – and higher yielding - investment strategies. It gives you more room for error, a luxurythose quickly approaching retirement agecannot afford.
"If you make a mistake [in your 20s], don’t worry about it," says Mastracci. "It probably doesn’t cost you much and it’s probably the best lesson you’re going to get."
