Early Adult Period
At this stage of life, long term retirement plans are probably the last thing on your mind, but it is still a good idea to think about the distant future in broad terms. It is also a period of time when you can accumulate some investment experience and make some mistakes that won’t be devastating.
Learning from small mistakes can help you to avoid big mistakes later in life.
While saving for retirement involves building wealth over the long term, everyone has immediate financial commitments and the largest of those is usually the cost of shelter or accommodation. It may be rent or it may involve the purchase of a house along with the associated mortgage payments.
For those who have children, a plan to assist with the expenses of a post-secondary education also needs to be considered.
The retirement planning process at this stage may involve simply setting a target date for your retirement and the kind of income you would like to earn in retirement. If your day-to-day expenses have been covered and these additional commitments have been satisfied, any excess income canbe used to begin a monthly savings plan.
A good place to begin is to take stock of your current financial situation by developing a simple household budget and balance sheet. Your budget represents your cash flow or income and expenses while your balance sheet represents your net worth. It is simply the value of what you own minus any outstanding loans. Both of these items need to be in place before your financial strategy can be developed.
<Balance Sheet Table>
Whether you choose to rent or to buy a home, the cost of accommodation requires a major financial commitment. Your choices in this area will affect the amount you will have available for investment. As a result, this topic needs careful consideration and is discussed in more detail later.
Over four years the tuition costs at a Canadian university can easily be over $25,000 in today’s dollars and books can add another $1,000 to $1,500 per year. Those figures don’t cover expenses related to accommodation, food, transportation, clothing or spending money.
Registered Educational Saving Plans (RESPs) are an important tool when you are planning how much you want to set aside for future education expenses.
Even if the cost of a child’s education cannot be completely covered, taking advantage of government grants by establishing an RESP account is a sound strategy. Each dollar in government grants is a dollar that you do not have to earn or borrow. In addition, any growth on your investments within an RESP is tax-free growth.
Every family will be different but taking advantage of the maximum grant by contributing $2500 per year to an RESP is a good start. If you can’t afford $2500, try to contribute what you can. The government grant that equals 20% of your annual contribution is free money.
Post-secondary education does not have to be a free ride for your children.
Students can help by working summer jobs and taking student loans. Their contribution can help to develop an appreciation for their education and it can provide a sense of accomplishment. But minimizing the liabilities they will face upon graduation will help them to establish themselves financially early in life.
In the beginning your investment program will probably be modest.
The major expense you may be facing at this stage of life is your accommodation expense. There is always the choice between renting and buying but the choice is not as straightforward as many would make it appear. For the first twenty years or more of your working life, mortgage payments may inhibit your ability to set aside significant savings.
A second major expense, as mentioned, can be funding post-secondary education for your children. The government provides incentives to help you achieve that objective.
Your first investment portfolio
Opening an account and beginning an investment program early, even if it is modest, provides significant benefits. This account can be a taxable investment account, a tax-free savings account or an RRSP account.
The first benefit is the knowledge you gain about the investment process and the financial markets.
What you learn about yourself and how you react to financial situations that arise can be just as important as learning how to identify investment opportunities.
Investors tend to learn much more quickly when their own money is at stake because one of the key elements involved in the decision making process is learning what their emotional reaction will be when their investments begin to gain or lose value.
You can practice your investing skills by making hypothetical investments, but because you aren’t playing with real money it is easy to be calm and objective. That changes when your own money is at stake.
Determining your ability to deal with the ups and downs of the investment markets will define what kind of an investor you will become. It is easier to learn that earlier in life.
The second benefit is that you are actually building wealth even if it is at a modest pace. One of the keys to wealth creation that is often overlooked is maintaining the discipline to contribute regularly to your portfolio.
Beginning early and developing good financial management habits will serve you well down the road.
The tables below illustrate the growth of investments and the difference between earning a low return on your investments and earning a modest return on your investments.
<Investment Growth Table #1>
<Investment Growth Table #2>
Mutual funds are a good choice to begin with in your investment program because they can be purchased in relatively small amounts. As time goes on, experience is gained and more money becomes available for investment; you can then look to add other elements to your portfolio. It might be exchange traded funds (ETFs), an individual stock, a corporate bond or one of countless other investments available to you.
The question of priorities often arises. Should excess income be dedicated to paying down an existing mortgage or should a savings plan be started?
At this stage of life, making additional mortgage payments is an excellent investment. You will be debt-free earlier in life which will give you the flexibility to begin a more significant savings plan at that time. Additionally, being debt-free can provide peace of mind in the event of illness, unemployment or any other unforeseen difficulty that may arise.
If you have already committed to making extra mortgage payments and still have excess funds available for investment, you can open an RRSP account, a Tax Free Savings Account (TFSA), an investment account or all three. If you have children, consider opening a Registered Educational Savings Plan (RESP).
Your working life often begins by assuming large financial and personal commitments. Debt may be high while assets are modest. Marriage, your first home and children may be introduced into your life. These are long term responsibilities and they need to be taken care of in the event of your absence.
Life insurance is protection against the loss of income in the event that the insured person dies. Those who survive you and who depend on that income benefit from the insurance policy. This is an important definition.
You do not need life insurance if you are single with no dependents, even if you have a mortgage.
You also do not need life insurance policies on your children because they have no income. You would suffer a severe emotional hardship but not a financial one.
Calculate the appropriate amount of life insurance for your situation and buy term life insurance.
• Your household budget represents your income and your expenses
• Your household balance sheet represents your assets (what you own) and your liabilities (your debt obligations).
• The government will provide matching grants of up to $500 per year for Registered Educational Saving Plans