This article comes together partly as common sense and partly as intuitive planning. I have borrowed some ideas from influences I’ve come across in my research, education and partnerships that I have formed in the investment business. These are some insights that I feel have bearing in today’s increasingly complex world of financial security.
RRSPs and Tax Free Savings Accounts (TFSA) are great places to start when young income earners start making money. Building a diversified portfolio within these investment vehicles is an efficient way to begin deferring or sheltering tax as soon as possible. RRSPs are designed as long-term savings program that you contribute to over your lifetime and are penalized heavily for withdrawing from (aside from the first time home buyers plan). As added incentive, you are given a tax credit for contributions. A TFSA is a new vehicle as of 2009, allowing for contributions of $5,000 per year, until 2013, where the limit jumped to $5,500 to account for inflation. Within it, your investments capital gain, dividends and interest accrue tax free. Any amounts withdrawn are tax-free, but can only be re-contributed the next calendar year.
It may sound overly simple, but it is truly difficult to set aside a certain amount or percentage from each paycheque, allocating it to an account that cannot be touched (unless you physically go into the bank and demand access). The act of entering the bank and withdrawing is usually a good enough deterrent to keep you from dipping into the saving account and really forces your hand only in the direst situations. This idea ties into the next one: investing early and often.
A quick example of investing is the stock market, which for argument’s sake uses a 9% annual rate of return over a long period of time. In this example, twins Liam and Bella both turn 18, and Bella starts investing $2,000 a year for eight years and then never saves a dime again. Liam doesn’t save anything for the first eight years but then saves $2,000 a year until he reaches 65. (Stated another way, Liam saves $2,000 a year for 40 years). Look at what occurs by the time they both reach 65 in the table below*. The underlying fact here is that they are invested in the market. Sitting in cash will not get you far as the value of a dollar is eroded year on year by inflation. Growing your dollars along with inflation can only be done by market investment. Getting in early, even a little bit, has serious benefit as displayed below.
A lot of people in their early income earning years have near-term goals like owning a home and starting a family. While owning a home is a fantastic goal that everyone should strive for, I stress diversity. Real estate is a great asset class, but is only one asset class. Many people quantify investments only in terms of real estate or something that you can touch and unless you’ve been in a city like Vancouver, the stock market has by and large outperformed the real estate market where capitalization rates (return on investment for a real estate asset) have been outpaced by the stock market noticeably.
This is a simple idea that often proves very hard to live by – especially in cities with high costs of living like ours, which includes high rent and temptations like nice restaurants and nightlife. Many people live paycheque to paycheque due to a lack of discipline when it comes to financial constraint. Foregoing that new car or vacation can be the difference between months of anxiety and months of peace of mind. Having a nest egg or a cushion can also mean the difference between early retirement and having to work well into your retirement years.
Many people go through life dealing primarily with a banker at their local branch who may or may not be sufficiently qualified to advise them on how to invest their hard earned money properly. You should seek out someone who a) you trust, b) understands you, c) understands markets, or d) can assess your situation accurately and implement a realistic and achievable plan for your financial success. Be aware of their recommendations – are they selling a branded product that they are associated with, or something that seems like a flash in the pan? You want to ensure that your best interests are being taken care of – and the best way to do that is by dealing with an impartial professional advisor.
*the early years investing example was derived from Edgepoint Wealth Management’s article “Read before your 18th birthday. A few things I wish someone had told me about money when I was your age.” by Tye Bousada.
Written for Vancity Buzz by Evan Davies, a registered Investment Advisor at Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp., Member Canadian Investor Protection Fund. The views (including recommendations) expressed in it are those of the author alone, and are not necessarily those of Canaccord. The information contained herein is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it does the author or Canaccord assume any liability.
Man with piggy bank image via Shutterstock