Financial security starts with financial literacy
According to a CIBC study in 2019, Canadian women control $2.2 trillion of assets. But that will almost double to $4 trillion by 2028 and could be a lot more if real estate is included. While that wealth is increasing, the need for basic financial and investment literacy has never been greater. I’m often asked what three investing tips I would put at the top of the list for women to know. Here they are.
1. Create tax-free dollars
Tax is the single largest cause of wealth erosion in Canada today and accounts for a 28% impact. So it’s important to shrink the tax take as much as possible. There is one sure-fire way to create tax free dollars:
Tax Free Savings Account (TFSA). The beauty of the TFSA is that you never pay tax on the investment growth inside the plan, and all withdrawals from the plan are tax free. So open a TFSA and max it out every year. And do it regardless of how old or young you are today.
Let’s say you are 30 years old today and make $50,000 a year. You have $10,000 in a TFSa and you contribute $5,000 at the start of each and every year until you stop working at age 65. Let’s target a reasonable 8% average annual compounded rate of return on the investments inside TFSA. By the time you reach age 65 in 35 years, you would have $1,067,412 in the TFSA.
If you were to invest this same amount in a taxable non-registered investment account using the same numbers, you would have $728,226 and paid a whopping $271,774 in tax. This is because the growth on your investments is taxed annually at your marginal tax rate (in this case 31.15%), leaving you an after tax-rate of return of 6.4%.
2. The“4 D” method to cutting taxes
Tax-saving doesn’t end with TFSAs. In fact, there are a number of tax-saving strategies that I call the “4 Ds”: deduct; defer, diminish; divide.
Deduct and defer. This is a strategy you’ll use when you put money into a Registered Retirement Savings Plan (RRSP). You get to deduct your contribution from your income. And tax on income earned from investments in the plan is deferred until you withdraw your money from the plan at retirement.
Divide and diminish. If you have children a Registered Education Savings Plan (RESP) will help you “divide” income by splitting it with your children, thus “diminishing” the tax. This structure allows you not only to save for your children’s post-secondary education but it also cuts your overall tax bill.
When contribute to an RESP, you are transferring future tax liability. You achieve “divide” by essentially putting money into your kids’ names as beneficiaries of the RESP. The investments in the RESP growth tax-free until your children withdraw it pay for a qualifying post-secondary institution. At that time, the income is taxed at your child’s tax rate, which will most likely be next to zero, while you will very probably be in your peak earning years with a tax bracket as high as 50%. You have just accomplished what may be a decade of tax-deferred growth. When it is done right, you will pay no tax on the growth, and your child’s college or university education will be largely paid for. And the kicker is that there’s an additional Canadian Education Savings Grant of up to $500 a year to a lifetime maximum of $7,200. It’s free money to add even more to that compound growth rate in the RESP.
3. Minimize investment costs
Investment costs can be a big hurdle to achieving good investment returns. Mutual funds, for example, are probably the most popular vehicle in Canada for investing for retirement. But the cost of holding a mutual fund can be very high. Fund managers’ compensation, advisor’s fees, and administration costs can push a fund’s management expense ratio (MER) to 2.5% or more. MERs of segregated funds are even higher ranging from 5% and up. This is paid out by the fund, reducing assets, and thus cutting the return to investors. A commission, or “load,” which is paid by the investor directly to an advisor or broker, will increase the cost of the fund even more.
In a strong bull market with stocks growing 10% to 15% per year, most investors don’t mind the excessive expense. But when markets slow down to more typical single-digit returns, that MER can really dig into your overall returns, especially in the longer term. A 5% annual return the market, for example, would be cut by the 2.5 percentage point MER in a fund that follows the market, leaving a 2.5% return. If inflation is running at 3%, your real return is already negative. Add in any taxes (in non-registered accounts) and you’re even deeper in the hole.
When choosing funds, look for cost efficiency. One solution is to use exchange-traded funds (ETFs) instead of mutual funds. ETF fees are typically less than 1% of assets. Some are just a few basis points above zero. With ETFs you can trim the overall costs by one percentage point or more. On a $500,000 portfolio over a 20-year period, that works out to a saving of $194,000. This is not chump change. So pay attention to the costs of your investment, not just the “price.”