The seven eternal truths of personal finance
No matter the business cycle or the trends, there are some things that never change when it comes to saving, building and managing money. Longtime Financial Post columnist JONATHAN CHEVREAU presents the third instalment of the seven eternal truths of pers
We in the financial media spill a lot of ink and airtime over investing, perhaps because following the latest hot stock can be a fascinating pastime for those so inclined. Who among us isn’t interested in what Apple is doing, or Google, Facebook or recent arrivals like Shopify?
But if you’re young and still in debt — whether student loans, credit cards or other consumer debt — you really shouldn’t be fretting about investing in stocks, equity funds or even “safe” fixedincome vehicles like GICs. What’s the point of owning a stock that pays a three per cent annual dividend, or a GIC paying one or two per cent per annum, when your credit-card debt is costing you 18 per cent a year?
No investment you own — even if it’s held in a Tax-Free Savings Account — is going to outperform the simple act of paying off highinterest non-tax-deductible consumer debt. In fact, if you’re in the top tax bracket, as Vancouverbased adviser Christopher Cottier of Richardson GMP points out, you’d have to generate a 29 per cent annual return pre-tax just to pay off 18 per cent annual creditcard debt after taxes.
Credit cards are the most probable cause of such consumer debt. Even though interest rates have been hovering near record lows since the financial crisis hit in 2008, credit-card interest charges have remained stubbornly high.
Speaking from my own youthful experience, it’s an easy trap to fall into a pattern of paying off only the minimum monthly payment. That’s what the credit-card companies would love you to do, but it’s almost the worst practice for anyone who cares about their personal finances. Pay off the entire balance in full each month and make a solemn pledge to yourself that you’ll never pay a dime in credit-card interest.
While student loans tend to levy much less punitive rates of interest, these too can cause trouble if they are neglected and you start to let negative compound interest eat away at your net worth.
Newly examined data from Statistics Canada reveals a massive upswing in privately held debt among post-secondary graduates. In only 10 years, while bachelor’s degree graduates saw a 5.2 per cent increase in public debt, private debt for that group shot up by 53 per cent. Private debt levels for Ph.D and bachelor’s degree holders have jumped between four and 11.5 per cent each year between 2000 and 2010.
The Canada Student Loans Program expects more than 40 per cent of borrowers will need more than the maximum available loans next year, which means many may resort to bank loans, LOCs and credit cards.
Another common source of trouble is falling behind on tax payments to the Canada Revenue Agency. A combination of latefiling penalties and compound interest on the debt can create liabilities that eventually grow bigger than the amounts initially outstanding. So even though I would suggest that those who are solvent should invest as much as possible in RRSPs and TFSAs, that may not hold for those with significant debts: whether it’s consumer debt or money owed the taxman.
The one debt I’d tolerate is mortgage debt, since for most young people, taking out a mortgage is the only way to get a first step on the housing ladder, and mortgage rates are much more reasonable than credit-card charges. At today’s high home prices, this is a significant undertaking. Even so, I’d strive to come up with a full down payment (perhaps financed through savings in a TFSA), then I’d aim to pay the mortgage off within five or 10 years, taking advantage of annual prepayment privileges (typically 10 or 15 per cent of the original principal owing). Difficult if you’re a sole breadwinner but doable if you’re half of a dual-income couple.
The nice thing is that the frugal behaviour required to pay down a mortgage can be continued once the debt is retired: At that point, if you continue to be disciplined and live well below your means (remember Truth #1!), you can use that behaviour to start building wealth.
If you’re well along the road to owning your home outright — I still say a paid-for home is the foundation of financial independence — you should try to avoid using that home equity to access more cash. During the financial crisis, the temptation to view home equity as a sort of ATM made things worse for many homeowners. I’d avoid reverse mortgages or Home Equity Line of Credits (HELOCs) except in cases of dire emergency, such as job loss.