Practical strategies for real-world challenges
Freshly-minted grads get all kinds of advice, from the stock commencement speeches to well-meaning words of wisdom from relatives, friends, and parents, all of whom have “been-there-done-that.” Some of it is actually valuable. Often, however, solid, practical financial advice is totally missing from the equation. And yet, in some ways, that’s the advice new grads need most as they start their careers and make their way in the world. Here’s what they need to know right now.
Get that debt monkey off your back
It’s important to take stock financially. Get a fix on your spending habits and on what you own and what you owe. Once you have a realistic picture of where you are now, you can start taking steps to get where you want to go.
Getting a paying job is, of course, your top priority. You’ve got to have an independent cash flow, because you can’t rely on the bank of Mom and Dad forever. For freshly minted graduates, the next single most important short-term financial objective is to start paying down any existing student debt as fast as possible.
Debt is insidious, and compound interest can make the debt load even worse. Develop a debt-repayment plan – and stick to it! Pay down principal whenever possible. Skipping payments or hoping for some sort of government “debt forgiveness” program is a non-starter And dodging a debt repayment, even for a student loan, will affect your credit rating, possibly impairing your ability to get a loan for a car or a mortgage for a home several years down the road. If you have difficulty meeting loan repayments in the short term, be sure to contact the loan officer at your school. They may be able to adjust loan repayment terms. But do not simply ignore those payments!
Live within your means
With full-time employment, possibly with a good salary, many new grads feel the lure of financial freedom, spending lavishly, usually on credit. But that can quickly put you right back into the debt crunch – and it’s much worse than student debt, because the interest rates on credit cards are stratospheric. Before you know it, you’ll be using all your cash flow to pay down credit card debt. Don’t become a slave to debt – avoid this trap!
Start building appreciating assets. Some advisers say you should save 10% of your gross income. With most grads in their early 20s, that’s probably wildly unrealistic. So save whatever you can, even if it’s only a few bucks a week. You’ll be surprised at how quickly it adds up. Especially if you invest the money in a tax-efficient way. And that means RRSPs and TFSAs.
Open a registered plan
Tax-Free Savings Account (TFSA). Invest the money in some good-quality mutual funds or ETFs, many of which typically let you make an initial investment for as little as $500 or even less. The interest, dividends, and capital gains generated in the TFSA are all tax free. And all withdrawals are tax free.
There’s no deadline date for contributions for the year, because there is no tax deduction available for contributions as there is for RRSPs. You can contribute any amount at any time you want through the year, as long as you don’t exceed your maximum. You have to be over 18 and have a valid Canadian Social Insurance Number.
You can invest in the same types of “qualified investments” as you would in an RRSP – which covers a lot of ground: stocks, bonds, GICs, mutual funds, ETFs, and more.
Is the TFSA worthwhile? Let’s say you are 25 years old today, and you are able to contribute $1,000 to your TFSA right away. If you then continue to contribute $100 every month for 25 years, at an average compounded annual rate of return of 8%, your TFSA would grow to over $97,000. Remember, though, that as you grow older, settle in your career, and increase your contributions, that amount will grow substantially. A TFSA of $1.5 million or more at retirement is entirely possible.
Registered Retirement Savings Plan (RRSP). The same principle of tax-sheltered growth applies to RRSPs. These plans let you contribute a certain percentage of your earned income every year, in return for which you get a tax deduction. Money grows in the plan on a tax-deferred basis, and is not subject to tax until you make a withdrawal. RRSPs are generally for longer-term retirement planning, and are useful once you get into higher income brackets (and you will). So at first, contribute as much as you comfortably can each year, but start early and do it consistently. Here are some ways to get that RRSP contribution going:
Automatic deposits. Make a direct deposit with every paycheque. Your money is invested and starts compounding that much sooner. If you’ve just landed a new job, check with your employer to see whether they offer a Group RRSP. These have the same structure as an individual RRSP, except that they are administered by the employer who engages professional money managers to run the plan, and individual investment choices are typically limited. But they have the added advantage of letting both employee and employer contribute to the plan. Contributions are tax deductible, and like individual RRSPs, tax on any investment growth inside the plan is deferred until the plan is collapsed.
Employee contributions are made by regular payroll deduction, and contributions result in a tax deduction. If the tax deduction results in a sizable annual refund, it can be applied to reduce your source withholding.