Raising a Family - How am I Supposed to Invest?
For most people with a young family there seems to be no time available for anything, let alone thinking about investing. But with children comes added responsibilities, making it more natural to think about the future to make sure you are not a burden to your children at retirement. Plus, parents need to start thinking about how to provide for their children’s education. We’ve all heard about the cost of education in the US which can be more than CAD $100,000 per year at a top private school. While Canada is a much less expensive place to study, it is still important to put money aside as tuition fees have increased more than 40 percent in the last decade.
For the few of you who have already started to invest, just continue with your good habits. Work toward maximizing your contributions to your RRSPs and TFSAs. But speaking of kids, there is also another investment vehicle that parents start to think about – the Register Education Savings Plan (RESP).
RESPs are like TFSAs in that they don’t get a tax deduction (use after tax dollars) and the money grows tax-free. But there are two important differences between the RESP and the TFSA:
There is a government top-up of 20% of the contribution up to $500. So, any investment up to $2,500 has an effective “government match” (like a company match for the RRSP(. So, it sounds like the RESP is superior to the TFSA just like an employer-matched RRSP was the best investment for Canadians. But wait, as with most financial decisions, it isn’t that straight forward.
The RESP can only be used for educational expenses. This means that if your children do not attend a college or university and you collapse the RESP, all of the government top-up (including the return on that investment) needs to be paid back. And, it becomes a serious taxable event.
So, assuming you are now maxing out your RRSP, should you go for the RESP or the TFSA? Unfortunately, this is another case where individual circumstances would lead to different decisions and your financial advisor can help come up with a solution that is best for you. But, generally, if you are confident that your children will be attending college or university, an investment $2,500 in an RESP will gain the full government top up. Money after that should go in a TFSA.
This is the time that most Canadians are considering putting aside money for another important and lucrative investment – personal real estate.
While, just like the stock market, there have been well publicized periods when housing prices have dropped, for most of history people have seen much of their investment return during their lifetime in the form of appreciation of their houses so the earlier you can get into the real estate market, the better.
Looking at housing prices over a long period, the average annual increase has been about 5.0% after inflation (in Toronto), generally at or above than the cost of a mortgage (also after inflation). While Canada does not have a mortgage deduction (which makes owning a home in the US an even better investment), the average return on investment has been good. Not to mention the satisfaction and security of owning the place you call home.
And, in which order should I invest or should I pay off my debts/credit cards? Sadly, there is no one size fits all answer to this question, but very generally speaking you should make investments/pay debts as follows:
Pay off credit card and any other very higher interest rate debt
RESP or Real Estate or TFSA
Other Lower interest loans (car loans)
Student Loans (depending on interest rate)
Non Registered Investment Accounts.
When thinking about this for your own person situation you can also consider the interest rate of your investments, accounting for the tax implications. For example, let's say you have $5,000 dollars available and can either make an investment into the stock market or pay down a 6% car loan. If we assume the investment in the market would yield a return of 7%, the your first impulse might be to make the market investment. But considering the tax rate on this incremental income will likely be 30-40%, the net investment return would be 7% X 70% (1-30%) = 5%, making paying down the debt a better investment. But comparing that same car loan to an RRSP investment (again assuming a 7% return), then you’d make the RRSP investment since you get both tax deferral (pay tax later, likely at a lower rate) plus a reduction in this year’s taxes since your overall taxable income is reduced. So the RRPS investment actually returns MORE than 7% (although the actual return would vary based on many factors) so the RRSP investment should come before the car loan pay down. And if your company provides a match then it isn’t even close – that’s why we are such big fans of the RRSP.
So, how are you going to buy a house if you are maxing out your RRSP? Three ways.
1) Be thrifty enough that you have enough money to max out your RRSP AND put enough aside for a house in a TFSA. Perhaps this strategy is only appropriate for super-savers but we have to mention it.
2) Borrow against your RSSP to make the down-payment for your house. Most RRSPs allow borrowing against the amount invested that can be a great method to raise the down payment for a house.
3) Just don’t max out your RSSP. We love investing and RRSPs but we’ve all lived actual lives and realize that the theoretical best course of action isn’t the best course of action when we consider our hopes and dreams (which are all not financial). So go ahead and put some money aside for that dream house, but just understand the trade off you are making.
What is a reasonable amount of put aside for investment? As with any financial decision, there are host of factors to consider – Your current income, debts, expenses (where you live), upcoming expenses, likely future appreciation in your income, etc. Your financial professional can help you wade through all the facts.
But, at this stage of your life, if you can manage to maximize your RRSP, put $2,500/year in an RESP and still put something aside for a house in a TFSA you are doing very well indeed.
This entire section has assumed you are a young person in your late 20’s or 30’s with young children. Of course, many of you have many other circumstances – single no kids, single with kids, married without kids, etc, etc. So, while the advice here is generally true for everyone, the specific guidance is different depending on your individual circumstances. For example, if you are married without kids, you have a tremendous opportunity to increase your savings rate to as much as 50% of your income and jump start your savings to retirement. And if you are single with kids, then you’ll need to adjust your savings expectations accordingly. On our site you can Get Help and get personalized advice.