Congratulations - you’ve landed your first steady job. Now, keep at it for the next four decades or so and you’ll be able to retire. Or, will you? Successful money management goes beyond just saving a portion of what you make. To really get the most out of your earnings, you'll need to put it to work in a few choice investments.
Not sure where to start? Whether you’re already planning for retirement or saving up for another life milestone such as your first home, here are the basics for beginning investors.
Current Canadian retirees benefit from two government-run pension programs: the Canada Pension Plan (CPP) and Old Age Security (OAS). The maximum monthly CPP payment in 2013 is $1,012.50. The current maximum monthly payment for the OAS is $550.99. Add that up, and you’re looking at $1,563.49. That works out to $18,761.88 a year.
It’s save to say that most of us wouldn’t be able to survive on that alone. And even that may not be available when you’re ready to retire; in the 2012 budget, the age of eligibility for receiving the OAS was moved from 65 to 67 years of age. This is the first of many anticipated changes to the federal pension programs to deal with the fact that Canadians are living longer, and there may not be enough younger ones in the workforce to support all the baby boomers through a lengthy retirement period. In short, the onus is on young people to plan on financing their own retirement funds.
Most Canadians are more familiar with Registered Retirement Savings Plans (RRSPs) than they are with Tax-Free Savings Accounts (TFSAs). This is in part because RRSPs have been around as a retirement savings’ vehicle for Canadians since 1957, and TFSAs only came into effect at the beginning of 2009.
Participating in both programs is similar in that you invest in a suite of options through your financial institution. But RRSPs get a boost from the fact that you get immediate tax savings (in the form of a deduction from your taxable income for the year in which they’re purchased). The tax-savings with TFSAs is that any money you earn on investments is non-taxable. (Down the road, when you do withdraw money from RRSPs, you’ll have to claim that as income at the time.)
While the upfront income tax savings from RRSPs may seem enticing, the fact is that if you’re just early in your career, and therefore making a relatively low income, you’re better off investing in TFSAs. Here’s why:
Let’s say you’re making a fairly low salary – the current national median income is $27,800 – and, you still manage to set aside $1,000 to invest. At the current minimum tax rate of 15%, your tax-savings may only amount to a few dollars. But if you invest that $1,000 in a TFSA, it could grow significantly larger over time. A $1,000 investment that grew at 5% a year would be worth $4,322 after 30 years.
If your career blossoms and you find yourself earning six-figures one day, you’ll be taxed at a rate of 26%–29%, making RRSP deductions a more-valuable consideration.
TFSAs also have another advantage over RRSPs in that you’re able to withdraw the funds whenever you want, without penalty. This makes them a useful savings vehicle for other big expenditures, such as the down payment on a house.
Keep in mind that both RRSPs and TFSAs offer the option of keeping your savings in cash, or investing them further in a GIC or stocks for further interest earning.
Check out this handy graph to learn more about RRSPs vs. TFSAs>
The downside with investments held within both RRSPs and TFSAs is that they’re tied to stock markets and the overall health of the economy. The general trend has been for these types of investments to grow over time, but major market crashes – such as occurred in 2008 – can have devastating effects on people’s investments. In fact, many Canadians had to modify their retirement plans when the economy tanked and took a good chunk of their nest egg with it.
The principal invested in a savings bond is guaranteed by the government, making them as close to you can get to a sure thing. But that safety comes at a price: the current series of federal savings bonds pay a mere 1% interest on the first year of the investment. And you don’t get any interest if you cash them in before the year is up.
Investing directly in individual stocks is the area where you can make the biggest gains, or take the biggest losses. But for every seemingly never-ending stock rise (Google’s $85 initial IPO price in 2004 has soared to approximately $1,010 in November 2013) there’s a reminder such as one-time stock market darling Research in Motion of how quickly things can change for the worse. RIM reached a high of more than $140 a share in 2008, but had dipped to less than $14 a share in 2013. You’ll also have to factor in brokerage fees for every transaction you make.