Debt-Free Forever (17 page)
Authors: Gail Vaz-Oxlade
You’ve been told you should be saving and you think that it’s probably a good idea. It’s just that stuff keeps cropping up, forcing you to spend your savings. The car breaks down, your son’s hockey fees come due, your daughter needs a dress for the dance, your husband wants a new TV, your wife is desperate to redo the kitchen. The list goes on and on and on. You squirrel away a few bucks and then, BAM, something knocks the money out of savings and into your pocket. Oops! How You Should Invest: You need to keep some money accessible for emergencies, but you would definitely benefit from locking the rest up where temptation can’t steal it. Think three-to five-year GICs and government bonds. You shouldn’t use anything too liquid (i.e., easy to sell) because the temptation will be to cash out and spend the money.
You get it. You’re determined to save. You may not have a lot to start with, but that’s not going to stop you. You’ve set up an automatic debit from your chequing account to a retirement savings account somewhere that makes it very hard for you to get to the money. And every six months, you increase the amount you’re saving by 10%, 15%, or 20%, so you keep
growing your savings. You’re learning all about investing. Ditto educational savings accounts, and whatever else will help you reach your goals.
How You Should Invest
: When choosing investments, you’re in the same boat as “passionately committed,” so read on.
You’re so committed to reaching your goal that you’ve actually taken an extra job and are directing all the money you’re making from that job to your retirement savings. You’re a fiend when it comes to using coupons, shopping on sale, cutting corners. And every penny you save goes immediately into your savings account. Yup, you don’t “save” (the verb) $10 without applying that $10 to your “savings” (the noun)! Whoo-hoo. You’re a train and everyone better get out of your way because you are determined to achieve your goal.
How You Should Invest
: Whether you’re very committed or passionately committed, your investment options are wide open, and should be tempered only by your knowledge and investment time frame—or how long it will be till you need to start using the money.
Knowledge you get, right? If you can explain the investment to your sister, mother, best friend, brother, and still want to buy it, go ahead.
Which brings us to time horizon.
How long you’re planning to invest has a big impact on the investment alternative you might choose. Pick the wrong
timeline and you could find yourself a little sad when cash-out time comes.
The longer you have until you will need to use the money—the longer your time horizon—the more time your investment has to even out its return, taking care of the volatility risk, but the more time inflation has to eat away at the value of your money. The trick is to match your time horizon to the investment you are choosing.
What does the time horizon of your investment have to do with what investment you choose? Well, it’s like this:
Fixed-income investments like certificates of deposit (GICs and term deposits) have no volatility and the return is guaranteed. You can’t lose your principal (the money you initially invested) and you know exactly what you’ll earn in interest on the day your certificate matures. The same holds for a bond or mortgage investment that is held to maturity. (If you’re actively trading bonds or mortgages, they behave more like equities, responding to market conditions.) So it doesn’t matter whether you go long or short, you’re guaranteed your return as long as you hold to the end of the term you choose.
Equities—things like stocks and stock-based mutual funds—are a whole different kettle of fish. They can be very volatile depending on their nature, some offering more price stability and others offering more opportunity for growth. Either way, they don’t work as short-term investments since they may be at a low just when you need the money and must sell them. They work as long-term investments, where you have time to ride out the highs and lows and average out your return.
Less than three years is considered a short-term investment horizon. Three to nine years is considered medium-term, and 10 years or beyond is considered long-term. Short-term investors should avoid putting the majority of their money in investments where the risk of losing that money is greater. Choosing fixed-income investments that generate a steady return while offering a higher level of security is a better idea. Medium-term investors can balance their investment portfolios using both equity and fixed-income alternatives. Long-term investors have the luxury of time and can, therefore, choose an asset mix that is weighted more heavily with equity investments. Since equities have historically outperformed all other types of investments over the long-term, people with an investment horizon of 10 years can benefit from the potentially higher returns equities offer because they have the time to ride out the natural volatility associated with the market.
As you get older, or as your personal circumstances or economic conditions change, and as your investment horizon shortens (yes, you’ll get older and closer to retirement, so your time horizon will go from 20 years to 10 to 5 and so on), you’ll need to rebalance your portfolio’s asset mix.
GAIL’S TIPSThe Canada Deposit insurance Corporation [CDIC] provides deposit insurance on eligible deposits at member institutions up to $100,000 per registration,
which means your principal is safe regardless of what happens to the bank. So your RRSP deposits are covered separately from your unregistered GICs, and your personal bank account is covered separately from your joint account. Deposits must be in Canadian currency and payable in Canada. Term deposits must be repayable no Later than five years from the date of deposit. For more info, visit the CDIC website—www.cdic.ca.
While saving for retirement is something most of us think about—at least from time to time—there are other reasons to save, including making sure we can help our children avoid a huge amount of student debt when they head off to the halls of higher learning.
Back when my children were born—so about 16 years ago—the RESP wasn’t the RESP we have today and I wasn’t convinced it was the best deal going. But over time, the product has improved, the legislation has been made more user-friendly, and the reasons to use it have become crystal clear.
There are still plenty of people in Canada who aren’t using an RESP to save for their children’s future education. Only about 35% of eligible kids receive the Canada Education Savings Grant (CESG). That’s the money the federal government gives you to put money away for your kids. Really? The feds want to give you money and you don’t want to take it? What’s up with that?
If you haven’t been contributing to an RESP for your kids, it’s not too late to catch up on the whopping $7,200 CESG you may have been missing out on. Starting in 1998, the CESG accumulates every year for a child until he or she turns 17.
While there is no maximum that you can put into an RESP each year, there is a $50,000 lifetime limit. And you can catch up for years in which you did not make a contribution. The basic grant room is $400 per year from 1998 to 2006 and $500 from 2007 based on a contribution of $2,000—$2,500 a year. The maximum grant a child can receive in a calendar year is $1,000 provided grant room is available and a large-enough contribution is made. Don’t be tempted to catch up too much at once or you could miss out on grant room. Each year you can catch up for roughly one year of missed contributions.
GAIL’S TIPSThe Canada Learning Bond provides $500 for low-income families to establish an RESP account and allows for an annual contribution of $100. Despite the fact that the government is giving parents money to save for their children’s future education, the program only has an 8% participation rate. If you haven’t started saving for your children, and can’t come up with the money for a contribution this year, find out how to take advantage of the Canada Learning Bond and put the money to work for your kids now.
Let’s say you made no RESP contributions for Molly McGoo, who was born in 2000. The total CESG room Molly would have accumulated by 2008 would have been $3,800 ($400 for the years 2000 to 2006, and $500 for 2007 and 2008). If you set up an RESP for Molly this year, you can contribute up to $5,000 and grab a grant of $1,000. You put in five and the feds give you one—that’s an automatic 20% return on your money before it’s even invested. And Molly would still have $2,800 of unused room you could catch up in future years.
How much you save depends in large part on how much you can afford. Aim for the maximum amount of CESG, which is $500 for current contributions and $1,000 a year if a previous year’s contribution is also claimed. If you can afford to put away more, do it. Post-secondary education won’t be getting cheaper any time soon.
GAIL’S TIPSI am not of fan of Group RESPs—typically called Scholarship Trusts—which have about 30% of the education savings market. A study prepared for the federal government found that group scholarship trusts have a number of drawbacks:
- You must pay an enrolment fee and make contributions according to a preset schedule.
- If you close a Scholarship Trust RESP before maturity, you forfeit the enrolment fee plus any
investment gains and government grant money. So if you can’t keep up with the preset contribution schedule, you lose. And, no, you can’t simply transfer the plan. They won’t let you. - Some scholarship trust plans deny payments to students who are entitled to these benefits under government rules because some scholarship trusts don’t recognize all courses of study. If your child chooses something outside the plan’s parameters, they won’t be able to use the money in the plan.
- If the group scholarship plan is cancelled for any reason, you get your contributions back, less their fees and without the investment income. The grant money is also repaid to the government and cannot be earned back later if new contributions are made for the same beneficiary.
- Scholarship trusts have high fees. The report notes that in 2006, 20% of gross contributions went toward fees.
If you haven’t opened up an RESP for your wee one yet, today’s the day. It doesn’t have to be a ton of money. Can you manage $100 a month? $50? $25? Just get started. And the next time the grandparents want to know what to get Molly McGoo for her birthday, a toy and a small contribution to her RESP will keep her happy on her special day and give her options in the future.
Pretty well everyone has heard the Save 10% Rule, but folks are still confused about what that means, so let me clarify. Save 10% means take 10% of your monthly net income (your income after taxes) and put it in long-term savings (like a retirement plan). If you have a pension plan at work, whatever goes in that can be counted toward your 10% long-term savings. If you also want to save for your children’s future education, that’s separate.
People are always giving me their excuses for why they don’t save. Which of these have you used?