Investing Basics for Millenials
Courtesy of Dynamic Mutual Funds, Posted 22 Apr 2016
Now that you are starting out in life there are many things to consider. Some, such as deciding your living arrangements and dealing with student debts, will be more urgent. However, setting up a savings plan should also be something you consider a priority. Retirement is probably 40 or more years away, but getting started now will have a dramatic effect on how much money you have later on in life and whether you can achieve all of your financial goals.
Everyone should have some short-term savings or ‘emergency fund' that can be accessed quickly when needed. This could be for things such as unforeseen car repairs or to help manage expenses in case you lose your job. Most people agree that you should set aside at least three months of living expenses. Short-term savings should be readily accessible and, ideally, earning some interest in the meantime. However, by definition, safe, liquid investments such as a chequing or savings account pay little or no interest. A reasonable alternative is a Money Market fund which can be accessed quickly (within one business day) and will pay somewhat more interest. Your Advisor can provide more details about these types of investments. You will need to consider the costs of getting money from other sources (such as your credit cards or other credit), as well as Employment Insurance and Short-Term Disability insurance, to determine how much of a financial cushion you need in your short-term savings. At the end of the day, you do not want to be tying up too much money in low interest-paying investments.
Registered Retirement Savings Plans (RRSPs)
RRSPs are the most popular way for Canadians to set aside money for retirement. These are plans created and administered under the Income Tax Act. There are many specific features of RRSPs, and your Advisor can provide you with details. The most important to keep in mind, though, is that money you put into an RRSP will give you a tax deduction in the year that you make your investment and, while inside the plan, will grow tax sheltered – which means you won't pay tax on the money in your RRSP until you withdraw it in the future (presumably, when you retire). The amount you can contribute to an RRSP is directly related to your income in the previous year. For example, if your income last year was $30,000, you would be allowed to contribute 18% of that – or $5,400 – to an RRSP this year. Be aware that an RRSP in itself is a legal structure, not an investment. To contribute to your RRSP, you must buy an investment that is RRSP-eligible; there is a very broad variety of such investments to choose from. In addition, there are two basic categories of RRSP:
These are RRSPs that you can set up directly with your investment dealer or bank. You are responsible for making your own contributions.
These are plans that are set up by your employer for the benefit of you and your fellow employees. Under this plan, your employer makes contributions to an RRSP in your name, on your behalf. Your contributions are deducted at source (directly from your paycheque) and in many cases your employer will match your contributions, which means you'll be setting aside more money than you would on your own.
Lump Sum versus Periodic RRSP Contributions
When you have an individual RRSP you will be responsible for making the contributions. Although you can make a lump-sum contribution at any time, there are definite advantages to establishing a regular contribution plan that automatically directs money from your bank account to your RRSP savings on a regular basis. These are usually referred to as Pre-Authorized Chequing–or PAC–plans and most financial institutions will allow regular contributions of as little as $25. By using a PAC plan you become used to the regular withdrawals from your account, which is probably easier in the long run than having to coming up with the money for a lump-sum contribution.
Tax-Free Savings Account (TFSA)
In 2009, the federal government introduced a new tax-efficient way for Canadians to save money: the Tax-Free Savings Account (TFSA). As of 2015, the account allows you to contribute up to $10,000 per year and invest it in a wide range of investments. Although there is no tax deduction allowed on the contributions (as in the case of an RRSP), the income earned in the account is tax-free and any withdrawals are tax-free. You can use the money in your TFSA to pay for such big ticket items as a car, home or travel. Money in it can be withdrawn tax-free at any time–and you can replace the money you take out of the TFSA the following year. As long as you are a Canadian resident 18 years of age or older with a SIN, you can open a TFSA.
Your Advisor can provide you with more information about the TFSA as well as assist you in establishing an account.
The Lifelong Learning Plan (LLP)
If you have left school but are considering going back, the LLP is a way to use your RRSP savings to pay for a full-time return to school. As with the Home Buyers' Plan (ask your Advisor for more information), the LLP lets you or your spouse essentially borrow from yourself by withdrawing money from your RRSP(s) and paying it back at a later date. The following link provides a good description of the LLP: Lifelong Learning Plan