Getting your first gig after graduating high school, college, or university is often a challenge. But now that you've landed a job, it's time to settle into learning how to excel at it and impress your boss. Also, now that you're receiving a steady paycheque, it's also a great time to start thinking about your personal finances.
Henri Miller, investment specialist and retirement planner for Scotia says that it's important to start working towards your financial goals early – especially if you are like many young people with significant student debt.
“It's extremely important that as soon as you start earning a steady income you also start thinking about your long-term finances,” he says. While not all recent hires will be making enough money to feel they can make a huge dent in their student loan repayment or retirement savings just yet, Miller believes it's important to sit down and figure out what your goals are and where you would like to be – and then start taking small steps to get there.
“You should ask yourself what you would like your life to look like. Do you want to retire at age 55 and travel the world? Do you want to one day buy real estate or would you prefer to rent in a city with expensive property values?”
The answers to these questions are deeply personal, so knowing these things about yourself is important and can help give you the purpose you need to work hard and create the future you want to see.
Because of the compound interest, if you start saving and investing early, you will have to save and invest less over time to have the same amount for retirement or save more for greater financial security and/or more retirement income.
Here are some of the key things you need to do to start your financial planning journey.
Make a budget
Having an idea of how much money is coming in every month and where you're spending it is critical so that you can’t overspend and make informed choices about how to spend your money in ways that reinforce your long-term goals.
Despite what some financial experts say, there is no one-size-fits-all template for budgeting – especially for young people these days, says Miller.
“Some experts will say that you should put no more than 30% of your income towards housing and that you should save 10% every month towards your future,” he says. “But if you live in an expensive city making a starting salary, both of those things might be difficult to do. Alternately, you might decide to put a higher percentage of your salary towards your long-term goals, if you're able to so, because that will help you potentially retire earlier.”
Figuring out how much you should spend on housing, transportation, utilities and other necessities is critical before deciding how much you can put aside for savings or for non-essential expenses. What you decide will depend on what kind of lifestyle you want to live now or in the future. You might decide to scrimp now, so that you can relax later.
But Miller reminds young workers that saving money and being thrifty aren't the only solution to a budget that's not able to do everything you want it to do.
“You could decide to take on a side hustle to increase your income or to use your budget to heavily invest in additional learning or opportunities that will help you grow your income significantly over time. Investing in yourself today can give you a higher income and a brighter future later.”
Take advantage of tax-deferred accounts
Now that you're working, you're eligible for both of Canada's tax-deferred savings accounts. Miller believes it's important to open up both a Tax-Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP) when you get your first job.
What tax-deferred means is that both types of accounts allow you to invest money in them so it can grow and compound each year without paying tax in the year that income was earned.
The investment accounts, however, work very differently, “With an RRSP, any dollar you put into it lowers your taxable income for the year of the contribution up to a certain limit based on your income. But any dollar you take out of it down the road when you retire will be added to your income tax in the year of withdrawal.”
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This works well for most people because when they're working, they're in a higher tax bracket then they will be when they retire.
“With a TFSA, you don't get a tax deduction today, but in the future when you take your money out there's no tax bill, fee, or penalty,” he says. “Another benefit of the TFSA is that you don't have to wait until you retire to take money out. You're able to take money out and put it back in up to your cumulative contribution limit without penalty.”
Automate your savings
You're busy with your new job. So, how can you make your finances as simple as possible? That's where automating your finances comes in.
“You can make savings easy by transferring money from your paycheque every month into your savings account or registered accounts,” he says. “If you do that, you will know that you're on track towards your savings goals and won't accidentally overspend because the money isn't in your account. That's what a lot of people call paying yourself first – making sure your long-term goals are taken care of so you don't end up with nothing to put into savings at the end of the month.”
Invest for long-term savings
Being young has benefits when you are looking to invest. Because you have a long time to prepare for retirement, financial experts often recommend that young people consider making more aggressive investments in order to potentially get a higher return and quickly grow their net worth.
“This can help you save more for your retirement over time – but it comes with some drawbacks,” says Miller. “Some people in their 20s are naturally more risk adverse and so they might still want to invest more conservatively. While young people should generally invest more aggressively, doing so will often mean that their finances will face more volatility and go up and down more over the course of the year. That isn't something everyone feels comfortable with. Choosing an investment strategy that works for you but still seeks financial growth is key.”
Take advantage of compound returns
Compound returns seem complicated – but all you need to know is that the younger you start investing, the more time your investments have to earn interest and then for that interest to earn interest. That process of earning interest on the interest allows your net worth to grow bigger over time.
I kind of look at it like a snowball rolling down a hill,” says Miller. “As it rolls, it gets bigger and bigger. So, the longer the hill is – the bigger your snowball or nest egg when you retire."
Dedicate your savings to specific goals
You've thought through your goals. You've set up an automated savings plan. There's just one problem: you're struggling to keep straight how far you are towards different short-term, medium-term, and long-term goals.
That's an easy fix when setting up your savings accounts, “One thing you can do is open different bank accounts for different goals. You might have an 'around the world trip' account, or a 'down payment for my first condo' accounts, as well as retirement accounts with different names on them, as well as a chequing account for everyday expenses.”
Doing this will help you quickly see where you are towards all your big goals with a quick glance.
Avoid raiding your retirement accounts
Life has a lot of ups and downs. Many people encounter strains on their finances at one point or another in their lives – maybe from an unexpected injury, the loss of a job, or a big life change. That can lead some people to look to their retirement accounts to help them out.
Miller says this is often a bad idea since you will have to not just pay taxes on the money you take out of an RRSP, but you'll also often have to pay penalties. He believes that it's far better to prepare for financial emergencies in other ways.
“It's important to keep some money aside in an emergency fund that could be used for things like fixing a car, making repairs on your house, or sudden unemployment,” he says. “Having an emergency fund that will cover your expenses for three to six months, as well as a low interest line of credit that you could tap into are much better strategies for handling emergencies.”
Getting started will feel empowering
You might be done with school for now, but you probably distinctly remember the feeling of handing in a project that you worked hard on and knowing that you're done. It's a feeling of deep relief.
That's just one of the things you'll feel when you start financial planning and know that you're on track to do things like pay off your student debt, pay your daily and monthly expenses, and even save a little money so that it can start growing to make your future dreams come true.
“I think the best thing financial planning does for young people is it gives them hope,” Miller says. “Once you have a plan, you often feel less anxious about the future and can start living with purpose and looking forwards to achieving your goals.”