We all think our parents know everything right? No? Well, I think everybody can at least admit that at one point or another, we all believed our parents could do no wrong. But as Millennials begin to navigate their way through the complex and often messy world of “adulthood,” I think we can all agree that there are many things our parents did (or still do) that we may not agree with. Personal finance is no exception.
You may have come across some alarmist news articles about how financially screwed (excuse my language) Millennials are. Housing prices are at historical highs, tuition expenses seem to be increasing at alarming rates all while job security and job availability continue to drift off into the abyss. So, you may be asking yourself, “Well aren’t you right then? Aren’t we all screwed?” The honest answer is: “I Don’t Know.”
No one has a crystal ball and unless you are one of the few lucky individuals that don’t need to worry about personal finances, you may be beginning to worry about your financial situation or at the very least be aware that financial security is something you should begin to think about.
The good news is that Millennials have something their parents don’t. Time. Time is your friend when it comes to personal finance and the earlier you start educating yourself about the in’s and out’s of money, the better off you’ll be. Don’t believe me? Why don’t you ask your parents and see what they have to say. Speaking of your parents… yet again, here are some financial lessons we can learn from our so called “Right-all-the-time” parents.
Avoid The “Asset Rich, Cash Poor” Dilemma
The “Asset Rich, Cash Poor” dilemma is an all-too-familiar one with many Canadians. Many Canadians who own homes hold a majority of their net worth in property, which makes many individuals “rich” (depending on your definition of the word) on paper, but cash poor. If you, your parents or someone you know falls under this group of individuals who are asset rich but cash poor, it is likely that they all run into similar problems.
Where do most of these problems come from? Simple, cash flow. Or, more appropriately, a lack of cash flow. Individuals who hold most of their wealth in properties and very little in cash (or other liquid investments such as stocks and bonds) can run into problems with debt-repayment, having enough income to support retirement and other cash-flow related problems.
What’s the solution? Well, the simplest solution starts at the beginning stages of home-ownership and is likely something you’ve heard over and over again: Live within your means. In the context of home ownership, don’t buy a house you can’t afford. Suppose you purchase a large home, struggle to make ends meet but manage to pay off the house after 30 or 40 years of hard work. If this piece of property occupies the majority of your net worth, you may need to find other, more regular sources of income to support your day-to-day activities or dare I say it…sell your house and downsize.
You may also decide to rent out part of your property for extra income or invest in dividend-paying stocks. Basically, anything that provides extra cash flow to make up for the cash tied up in a house or property can be used to avoid this problem. Although, considering the price tag attached to your home is likely your best bet in avoiding the “Asset Rich, Cash Poor” dilemma.
Start Investing Early
This is something that I am going to guess everyone has heard of before. If you are one of those people then I apologize for the repetition and if you have never heard this before, listen up.
Remember when I said time is your friend? Yes? Good. When it comes to personal finance and investing, time is your friend for two reasons. The first is compound interest. Starting to invest your money early allows you to take advantage of compound interest. This is just a fancy way of saying that it allows time for your money to make money. Don’t believe me? Use this compound interest calculator to see the difference between investing the same amount of money starting from the age of 25 versus the age of 35. Pretty big difference, isn’t it?
Start investing early through an online brokerage or a robo-advisor and make compound interest your friend. The second reason time is your friend is it gives you the ability to educate yourself. The earlier you start managing and investing your own money, the better educated you become about navigating the stock market, making large financial decisions and most important of all, it gives you time to learn about the financial planning strategies that you are comfortable with.
When you getting started as an investor, investing through Tax-Free Savings Account (TFSA) make a lot of sense, as it allows you to avoid paying taxes on your returns. However, as your income grow and you get closer to retirements, investing through Registered Retirement Savings Plan (RRSP) account will become more and more attractive. Those accounts are not tax-free, but they allow you to reduce your taxable income and to only pay taxes when you withdraw the funds,
Don’t believe me that time is your friend? Why don’t you ask your parents if they wish they had started saving and investing their money earlier? I would bet not one of them says they hadn’t wished they’d started earlier.
Diversify Your Investments
Ever heard the phrase “Don’t put all your eggs in one basket?” Chances are, if you’re an avid reader of personal finance articles or are interested in managing your own money, you’ve probably heard this saying before. If that’s the case, I’m sorry but you’ll have to it one more time here.
So, what does this have to do with personal finance and investing you might ask? Well, consider this. Imagine you work hard your entire life, save your money and invest all your savings in one (or maybe two) companies. What happens if one of these companies goes bankrupt? However unlikely you may perceive this to be, it can happen, and it can financially cripple you for the remainder of your life. What’s the solution? Simple: diversification. Diversification is a fancy word for dividing your investments into multiple stocks, bonds and other investment vehicles to minimize risk.
Just like the days of working for a company for 30 years, clocking in 9 to 5 and collecting a pension are diminishing, the old-guard method of investing in just a handful of stocks is losing its relevance. As stock markets are becoming more complex and growing in sheer size, it is important that individuals managing their own money diversify their investments. Whether it be buying 50 different stocks or simply diversifying revenue streams, diversification allows you to minimize your financial risk and will help you avoid large financial losses in the long run.
Now, perhaps you’re asking yourself “But if I invested all of my money in Apple or Amazon, I would be rich! Wouldn’t I?” The answer is yes. Yes, you would be rich if you invested all of your money in Apple. But what if you invested all of your money into Kodak or Enron or AIG? Don’t know any of these companies? There’s a reason for that. This is why diversification is your friend. So, avoid the old-school way of investing and diversify your investments. Your future self with thank you for it.
Top Up Your RESP
While you may not have kids just yet, it may be a good idea to understand how a Registered Education Savings Plan (RESP) works and how it can help you and your (future) children. Before I get into the nitty-gritty of what an RESP is, I want to ask you one simple question: “Do you like free money?” If the answer is yes, then pay attention. If the answer is no, you may want to get yourself checked out.
In its simplest form, an RESP is a government-sponsored savings account that allows you to save and invest for your child’s education. These accounts allow to you save your money and invest in whichever investments you see fit, whether they be stocks, bonds, ETF’s or any other sort of investment vehicle. Need a refresher on these sorts of products? Check out our article explaining different types of investments such as stocks, bonds and ETFs!
So, what makes this type of account different from any other type of savings account? The “free” money of course! All contributions to RESP’s are matched 20% by the Canadian government allowing you to save more money for your child’s education! For example, if you contribute $2000 to your child’s RESP account, the government will contribute $400! ($2000 x 20% = $400) Sounds like a pretty sweet deal, right? Well, it doesn’t look like all of our parents got the message. In fact, research conducted by the Royal Bank of Canada (RBC) concluded that Canadians have set up RESP’s for only about half of all eligible beneficiaries. That’s a lot of free money to give up!
What does this mean for you? If you are planning on having children in the not-so-distant future, you have to know what RESPs are. You will need your child to be born and have a social insurance number before you can open such an account, but it’s something you should know about now.
Don’t Underestimate Your Retirement Needs
One of the biggest problems facing the baby-boomer generation is simply the fact that people are living longer then they had expected. Now before you assume that I think this is a bad thing, let me clear the air. This is a great thing. Longer life expectancies mean more time with friends and family and more time to enjoy life. Unfortunately, at some point reality hits and many individuals may be thinking to themselves, “Uh-oh, I didn’t think I would live this long and I haven’t saved up enough money to retire!” This is an all-too-common problem these days.
There isn’t much to do to about people living longer. In fact, I hope life expectancies continue to go up. Increased life expectancies are typically a signal of technological innovations in health care and more stable socio-economic conditions. All I’m trying to say is I’m all for living as long as I can.
Now, what does any of this have to do with personal finance and what can Millennials learn from this? Longer life expectancies mean more expensive retirements. It’s as simple as that. If someone is living longer, they need more money to live. Not only will you need to continue covering basic living expenses such as food, you’ll probably need to spend more money on health care. In fact, health care costs are one of the largest costs for retirees and large medical expenses can often cause immense financial stress for many people.
So, what can Millennials do today? To make sure you don’t fall into the “I-don’t-have-enough-money-for-retirement” trap, there are two simple actions you can take today that your future self will thank you for. The first thing anyone should do is start. Start investing early and often. The earlier you start, the faster you can grow your investments. The second thing you should do is make a plan.
Make a budget, list your goals and write down whatever else you think will help you reach financial freedom and follow your own plans as closely as possible. Just be sure to change your plan as you get older, start having children and start buying real estate. It’s unlikely your financial plan you made when you were 20 years old will work for you when you’re 30. You follow these two pieces of advice and I can guarantee you will thank yourself when it comes time to throw in the towel. (Career-wise, of course)
On a finishing note, I just want to say that not everyone’s parents have fallen under one of the traps above. I believe our parents have done an amazing job raising our generation. I mean, think about all the new ideas Millennials are coming up with everyday! If you ask me, it’s pretty amazing stuff. But like any generation, we should aim to learn from our parents and if that means living a happy, healthy life free from financial stress, then hey, why not?