Rising home prices and education costs have increased the number of young people choosing to live at home with their parents. The latest Canadian Census (2016) shows that 34.7% of those aged 20 to 34 live with at least one parent.
Among the provinces and territories, Ontario has the largest population of young adults living with their parents at 42.1%, an increase of 20.3% since 2001.
One of the perks of these living arrangements is an increase in financial support. However, with independence being delayed for many young adults, some may feel that there is plenty of time to get serious about things. The idea of one day being old and retired hasn’t had time to sink in. RRSP? TFSA? GIC? HISA? IDK!
But if you aren’t careful, you can lose out on saving strategies that can take a lot more sacrifice in later years to achieve.
Here are five common money mistakes people make in their 20s.
1. Carrying a credit card balance
It can be easy to get a credit card and even easier to click on those “buy” buttons. You may have no choice but to buy essentials on credit. And suddenly, your bank account doesn’t have enough to cover your monthly balance.
Or, even if you’re not overspending, you may think you only have to pay the minimum by the due date.
If you don’t pay off the full amount of your balance monthly, your credit card company charges interest on the outstanding amount based on your annual percentage rate (APR). The average APR is 19.99%. The interest charge you see on your monthly bill is a daily rate calculated by dividing your APR by 365 and then multiplying your current balance by the daily rate. That amount is added to your bill.
If you don’t pay off your full balance next month, you will end up paying interest on interest, as well as what you buy. Since interest is a percentage of what you owe, the more you owe, the more interest you pay.
This debt can balloon fast.
Worse, if you don’t pay even the minimum payment on your bill, it will affect your credit score.
Good credit history is necessary to qualify for loans with lower interest rates, mortgages and is often required for rental applications and insurance. Depending on the industry you work in, it may even be necessary to gain employment.
2. Sticking with a starter credit card
Typically, starter cards have lower credit limits or may not have many perks. Not only that, but starter credit cards don’t let cardholders earn rewards points or cash back as quickly as more premium cards.
For these reasons, once you build a good credit history, you should consider getting another credit card that will do more for your overall finances.
For example, upon graduation, students will commonly swap out their student credit card for a standard one. You may find that you can access higher cash back and reward rates or lower interest rates over time.
While finding a great card to upgrade to is a fantastic way to earn more rewards and cashback, don’t get too excited and start applying to every credit card you see. Instead, do your research and choose the right credit card that fits your lifestyle.
You can generally qualify for a card with a higher credit limit once you have a substantial credit history. A higher credit limit helps keep your credit utilization ratio below 30%, which can increase your credit score.
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3. Not investing money
Compounding can be your friend when you start investing early. Compounding is the growth on how much your money grows.
For instance, if a $100 stock goes up by 10% to $110, and you leave it there, the next 10% will be worth $121, rather than $120.
After 20 years, if it continues to go up by 10%, you will have $672.75, earning you $572.75 more than if you just put in that $100 in 20 years.
Of course, that simple example assumes a steady growth at a made-up 10%, whereas stock values go up and down at different growth rates in real life.
Compounding can also work for fixed-income investments, like guaranteed investment certificates (GICs) and high-interest savings accounts (HISAs), that grow through interest rates. At least a part of your savings should be in these because they are less risky ways to invest, protecting the amount you put in, unlike stocks.
When you start early, compounding boosts your growth. Say you invest $5,000 at age 25. At age 65, at a return of 5% a year, it will have grown to $35,200. And if you add $1,000 a year to your initial $5,000, it will grow to $156,000. Of course, returns vary widely and can be taxed, and inflation can eat away at your money.
4. Not opening an RRSP
A registered retirement savings plan (RRSP) is one long-term savings option that has a specific advantage: you get a tax break when you contribute.
If you hold a social insurance number, have earned income and filed a tax return, you can contribute to an RRSP up to 18% of your earned income from the previous tax year. You can then deduct the amount you contribute from your taxable income that year.
One important consideration is whether you expect your income to be less in retirement than now. This is because you pay taxes on what you withdraw from an RRSP. So you could get more of a tax break on your higher income during your working years.
You should know that there are penalties – usually 1% per month on the excess – for contributing over your limit. You can find out what that is on your last year’s notice of assessment, or through creating an online account with the Canada Revenue Agency (CRA). The maximum for 2020 is $27,230.
You are also penalized for withdrawing money from an RRSP in increasing percentages the more you take out. Once that amount is withdrawn, you lose that contribution amount.
However, there are two exceptions: the Lifelong Learning Plan and the Home Buyers’ Plan, which allow you to “borrow” from your RRSP before retirement to fund education or a home purchase.
5. Not taking advantage of a TFSA
Once you hit 18, you can open a tax-free savings account (TFSA), as long as you have a social insurance number. Currently, you can put a maximum of $6,000 a year into a TFSA.
Some people may be confused by the “savings” in the name. You can hold most types of investments in a TFSA, from bonds to GICs, ETFs, mutual funds, or stocks.
The advantage of a TFSA is it allows you to build your savings tax-free. While, unlike an RRSP, you don’t get an income tax reduction for the amount you put in, you can take money out of a TFSA without paying taxes on what you take out, or any growth on qualified investments in the account.
If you don’t contribute your maximum one year, it can carry over, building your contribution room. If you suddenly find yourself with a stash of cash, you may choose to deposit it into your TFSA. But first, you will need to check your contribution room through the CRA, either through your latest tax return (notice of assessment) or through creating an online account.
But, if you overcontribute, you are taxed 1% on the excess every month until you withdraw the amount that is over the limit.
Compounding also applies to TFSAs. The earlier you start, the more growth you can realize.
One thing you can do to cut down on “putting off” syndrome is to automate things like savings and bill payments. If you have a steady income, you can set things up with your financial institution to automatically deposit funds into investment or savings accounts or move money to accounts when bills come due. Over time, there is a good chance you may find yourself comfortable enough to automate everything from retirement investing and even income tax preparation.
Boosting your efforts now can pay off in the future when life gets even more complicated.