It’s hard enough for professionals to sock away a chunk of money each paycheque to invest, but it’s even more difficult for 20-somethings who barely make enough to cover rent. But don’t despair; while it’s never too early to start saving, younger Canadians need to approach their portfolios in a far different way than older people might. Focus on retirement? Save that for later, says Jason Heath, a financial planner and managing director at Objective Financial Partners.
The top priority for people in their 20s should be to set aside money for shorter-term goals like paying for school, buying a car or building up a down payment for a house. While that makes intuitive sense, it’s not the message the financial industry tends to tell this cohort. “There’s a lot of push from the industry for these individuals to get their money into RRSPs,” Heath says. “But advice about being young and [the magic of] compound interest–that’s something they should try and ignore.”
Just like everyone else, 20-year-olds must set savings goals. But unlike older investors who might be focused on retirement, young people are often planning for some heady stuff, like marriage, children and home ownership.
It’s hard to pinpoint when exactly those life changes will arrive, but your expected timelines around these life events will inform how you should invest.
In most cases, young people will need to access their cash sooner rather than later. With that in mind, the ideal portfolio for someone at this stage is a TFSA filled with GICs, says Heath. What about RRSPs? An RRSP makes the most sense if your tax bracket in retirement is expected to be lower than it is in the years you contribute. That’s the not the situation most fresh-out-of-school 20-somethings find themselves in. Fortunately, the TFSA still allows you to grow assets tax-free.
There is one exception: if you want to take advantage of the Home Buyers’ Plan, which allows you to withdraw $25,000 from an RRSP tax-free, as long as it’s for a down payment. Even in that case, it’s better to contribute to the TFSA first. Then when you’re ready to buy the home–and are presumably earning more than you did when you first started saving–withdraw the funds from the TFSA and deposit them into the RRSP for three months before you buy. You’ll get a larger tax refund and can then withdraw that money to pay for the home.
In the meantime, owning GICs inside your TFSA keeps your capital as safe as possible, since the money will need to be withdrawn in a few years. However, it can be a challenge to generate a return with GICs today. Bonds pay between 1% and 3%, but a bond fund charges between 1% and 2%. “That doesn’t leave much of a rate of return after fees,” says Heath. Plus, with interest rates rising, it’s possible that bond funds will lose money over the next several years. Look for a GIC that pays 2%, which is the rate some credit unions offer.
To help boost returns in the short-term, young investors can opt to own some equities inside their TFSA, on top of their GICs. If you can’t stomach losses, then only have a small amount in equities, if any at all, says Heath. Someone who can handle more risk could have up to 10% of their short-term assets in equities. “It really depends on risk tolerance,” he says. “Some investors would not be willing to risk losing a penny of money they need in three years.”
Still, buying and holding specific stocks can pay off, especially if big life events get delayed. “Have a little stock exposure, just in case you don’t end up needing the money in the short term,” says Heath. Just keep in mind equities are volatile, rising and falling with the markets, so it could be bumpy ride.
Instead of individual stocks, mutual funds or exchange-traded funds (ETFs) are best. They’re diversified and easy to buy with little money. Heath suggests owning three equity funds—Canadian, U.S. and international— and splitting the assets evenly between each one. Many Canadians fall into the home bias trap–they buy mostly Canadian investments—but first-time investors are even more prone to this problem because they don’t know better. “The main thing is diversification,” he says.
ETFs do charge transaction fees, so those who have less than $50,000 to save could end up paying a lot if they contribute on a regular basis. Low-cost index mutual funds may be the better option when you’re just starting out, says Heath. There are no transaction costs and management expense ratios are lower than on actively managed funds.
Ultimately, the goal for every 20-something should be to save the little cash they have for life’s milestones. Once those are out of the way, then you can start thinking about retirement. “You’re going to need to use some of your savings in your 20s for life events that are far more important at that age than retirement,” he says.