So you’ve found a job – congratulations!
Now, you have to resist the urge to spend all of your hard-earned money as soon as you get paid. A little bit of a splurge is okay, but once you’ve gotten over the initial excitement of securing a steady income it’s time to start thinking about saving for a rainy day.
Before you start to worry, let me begin by saying that for many, the world of finances can be extremely confusing. You may have only just learned how to put together a budget, and now you’re hearing about things like RRSPs, TFSAs, GICs, the stock market and inflation.
If you’re feeling overwhelmed by the number of strange-sounding acronyms out there, know that you’re not alone. The good news is that it only takes a bit of independent research to develop a basic understanding of your options for saving and investing.
This article will give students a brief overview of your most common options for helping your money to grow. Whether you’re saving for higher education, a house or your retirement, knowing how to maximize your savings is always a good thing.
Common Terms for Investing/Saving
Registered Retirement Savings Plan (RRSP): A kind of investment plan specifically designed to help a person save for retirement. They can be made up of several different kinds of investments, like GICs, mutual funds, stocks or bonds.
RRSPs are helpful for two reasons: contributions are deducted from your taxable income (up to a point), and you do not pay tax on the interest you earn until you make a withdrawal. This is beneficial because by the time you are retired and ready to withdraw the funds, your income will likely be lower than it was while you were working, and so the taxes you pay on the profits you made from your RRSP will be lower as well.
You can technically withdraw funds from an RRSP at any time, but if you make a withdrawal before you are retired you will pay a penalty unless you use the money for post-secondary education or to buy a home.
Tax-Free Savings Account (TFSA): This kind of savings account allows you to contribute up to $5,000 each year of after-tax income without having to pay taxes on any of the interest you earn. You can withdraw from a TFSA at any time without having to pay a penalty, and any unused contribution room is carried forward to the next year.
Guaranteed Investment Certificate (GIC): Also known as a term deposit, this is an investment with a financial institution for a set period, ranging from one month to 10 years (the longer the term, the higher the interest rate). GICs are low-risk investments because they have a fixed rate of return and the principal is guaranteed.
Mutual fund: An investment where your money is pooled with money from other investors, handled by a professional fund manager. Mutual funds are appealing not only because the funds are professionally managed, but also because they are diversified and readily available. Plus, the investors have some say in where the money is invested (e.g., in certain industries or sectors) and the funds can vary from low- to high-risk.
Stock: Companies issue stocks or shares and the investors who purchase them become a partial owner of the corporation. Stock prices and returns fluctuate depending on the state of the overall economy and how well the company itself is doing; when a company does well, its stock rises in price, and vice versa.
Stocks can provide two kinds of income: from selling the shares you own (at a time when they are worth more than what you paid to buy them) or from dividends (corporations give their shareholders a portion of the company’s profits, proportional to the number of stocks they own). Generally, stocks are considered to be high-risk since there is no guarantee that a stock will do well. However, stocks offer the possibility of high long-term gains, which is why many people choose to take the risk.
Bond: When you buy a bond, you are loaning your money to an entity (a company or government) for a set period of time at a fixed interest rate. Bonds are considered very safe investments and they have a high liquidity.
Cash equivalents: These are highly liquid, very safe investments that can be easily converted into cash, though they usually have the lowest rates of return. There are three kinds of cash equivalents: savings accounts, which you are probably already familiar with, treasury bills (short-term investments backed by the government) and money market mutual funds (open-ended mutual funds that maintain a net value of $1 per share, but vary in the rate of interest they earn).
After-tax income: Your take-home income after you’ve paid taxes.
Contribution room: The total amount you can contribute to an RRSP or TFSA in a given year; in the case of TFSAs, the contribution room accumulates every year (going back to when the program started in 2009). For more information please contact the Canada Revenue Agency.
Diversification: Refers to combining a mixture of investments in one portfolio in order to minimize risk and maximize gains.
Inflation: The persistent increase in the general price of goods and services and the corresponding fall in the purchasing power of money. Inflation is measured as a percentage; as a rule, your investments should offer a higher rate of return than the rate of inflation.
Interest: Income earned on money you loan or invest. Compound interest is income earned on both the principal sum you invest and any accumulated interest.
Liquidity: The degree to which an asset or investment can be easily and quickly converted to cash.
Principal: The original amount invested, separate from any interest earned.
Rate of return: The rate of profit on an investment, usually expressed as a percentage.
Taxable income: The income on which you must pay taxes, usually your gross income less any deductions, exemptions or adjustments you are eligible for in a given year.
Tax-deductible: Refers to something that can be subtracted from your gross income to reduce your taxable income, such as a contribution to an RRSP.
Things to keep in mind
It’s only possible to begin investing if you have money to save; if you are in debt (especially student debt), it may make more sense to prioritize paying it off before starting to invest.
Certain loans and credit card debt should be paid off as soon as possible since the interest you’re being charged usually far outweighs what you can earn through investing. The key here is being in control of your finances. If you don’t already have a budget, now is the time to create one – it’s the best way to make sure you limit your spending and stay disciplined in your efforts to save.
If you’re not sure where to start, a TFSA or other high-interest savings account is a great place to start. mainly because of the flexibility they offer. In addition to helping you to save for your retirement, a TFSA can be used towards a big purchase or it can act as an emergency fund since you can withdraw without incurring a penalty.
However you decide to start, the best decision you can make is to start when you are young. It will give you time to experiment, take advantage of higher interest rates on long-term investments and benefit from compound interest.
When deciding which kinds of investments are right for you, carefully consider your current financial situation. Ask yourself how much you are able to save, how willing you are to take risks and whether you may need to access your money earlier than anticipated. When you are ready to start saving money you should consider hiring a financial advisor to help you manage your investment(s).
In the meantime, seek out additional information about the options available to students; talk to your parents or your bank and do a bit of research online to learn more about how you can make the most of your money.