A TASTE FOR THE FUTURE
Putting away money in an RRSP a good way for younger investors to reach mid-term financial goals,
Kyle, 25, is starting his career in a comfortable financial position. The GTA resident paid off his student loans last year and has no other debts. He’s living at home and puts 30 per cent of his $47,000 salary, or $1,342 a month, toward savings. He loves his communications job at the local health centre. He’s been there for just over a year and can join the hospital’s defined-benefit pension plan in two years’ time. The problem Kyle has money that he wants to invest, but isn’t sure of the best overall strategy. How do you invest when you have a lot of different goals? For instance, Kyle wants to move out in two years, take a trip to Europe and save for a home. He also wants to put money away for retirement. The particulars Cash saved up: $5,000 Expenses: $1,600 a month Money available to invest: $1,342 a month The plan Goals with different time horizons make investing tricky, says Shannon Lee Simmons, a financial planner with New School of Finance in Toronto. Kyle needs to put his goals in one of three categories: short, medium and long term. All three require different investing strategies.
Kyle’s short-term goals include moving out of his parents’ house and a European vacation. Simmons calculates that Kyle will need $3,000 for first and last month’s rent and $4,000 for his trip. Simmons also recommends Kyle include a $5,000 emergency account to start under this bucket.
His short-term savings over the next two years should be $12,000. Kyle already has $5,000 saved up, so Simmons suggests saving $292 a month for the next two years toward rent and his trip. Short-term savings should not be invested, Simmons says. “They should be in safe, high-interest-rate savings accounts,” she notes. “Money we need in the short term cannot handle any market volatility. Kyle needs these funds in the short run.”
Kyle’s medium-term goals are over the next five to10 years. He sees an engagement/wedding in his future, and also wants to save for a down payment on a house, or potentially so he can go back to school. He’d like to save $50,000 toward these goals.
Simmons says a Registered Retirement Savings Plan could support both the down payment and the return to full-time post-secondary education. Participating in the Home Buyers’ Plan or Lifelong Learning Plan would allow Kyle to withdraw from his RRSP without penalty. He would, however, have to pay those funds back over a specified time period.
A tax-free savings account could also be used for his medium-term goals. That would mean Kyle would be contributing after-tax money and not receive a tax deduction. But the upside is that TFSA money can be invested in everything from mutual funds to stocks. Any gains he earns on those investments would be tax-free.
Simmons suggests allocating $750 a month in the TFSA to go toward his medium-term goals. Starting that account keeps his options open. “He has a lot of conflicting goals and the TFSA will ensure he remains flexible,” she says.
As for investment strategy, his money could handle a little bit of market volatility. Simmons determined that Kyle’s risk tolerance was moderate, and says “Kyle should ensure that he’s diversified between asset classes and should ensure that he holds some fixed income and equity,” she explains. “With a balanced investment strategy, he can reduce volatility while still attempting to grow his money.”
As for Kyle’s long-term goals, he wants to save for retirement. Simmons notes that Kyle will be in a defined-benefit pension plan two years from now. “This will provide him with guaranteed inflation-indexed income in retirement if he stays at this job,” she says.
However, she advises Kyle to squirrel some money away toward retirement in the meantime. She suggests $300 a month into his RRSP. “This money has a long-term time horizon of 35 years,” she explains. “He can handle an aggressive-growth asset mix for his long-term assets since he has the time horizon and the risk tolerance to handle volatility.”
Simmons still suggests a balanced portfolio between fixed income and equity. However, given the long time horizon and his aggressive-growth risk tolerance here, he can handle a very growth-oriented portfolio with as much as 80 per cent of his money in equities.
Kyle wishes to invest in low-fee, passive investments, and would like to stay with his current financial institution.
Simmons suggests investing in index funds that could have management-expense ratios of between 0.33 per cent and 1 per cent.