Where Should I Start?

While paying off credit cards is a must, slowly paying debt and building assets along the way isn't the worst idea ever.

Happy Friday morning friends!

We're going to try something new over the next few weeks: I'm going to publish a series of articles designed to be a jumping off point for anyone visiting or subscribing to Toonie for the first time.

If you find the discussion to be a little below your pay grade, feel free to pass. But I do implore you to still check in from time to time — there could be a few tips here and there that pop up that you maybe haven't heard before. (I'm hoping this week's tax points are a strong example of this.)

Last week, I reached out to ask for some feedback from any and all readers and I have received at least a few emails as a result. Please always know the offer stands: If you have any feedback whatsoever, shoot me an email and let's chat. 

joshginter@hey.com


Quick Thought of the Week

I had a brief discussion with some folks over the last few months about the premise of having $1 million in your bank account. Most joked about how they'd retire on the spot, as $1 million was more than they could ever need to retire.

But let's say you earn 3% interest on that $1 million in a savings account. You come away with $30,000 pre-tax per year in interest — let's say $24,000 after-tax.

Is $24,000 per year enough to retire on? If you own a home, property tax will probably be between $2,500 and $4,000 (or more) per year. Vehicle insurance (at least in Manitoba) is at least $1,500 per vehicle. You'd probably spend the better part of $7,000 or $8,000 on groceries per year. Perhaps you’d spend $2,400 on fuel for your vehicle in a year. 

Needless to say, $1 million isn't enough for a young person to quickly retire on. If the interest is supplementing a Canada Pension Plan benefit or an Old Age Security amount, then perhaps. 

But if I were to stumble into $1 million right now, I can guarantee I wouldn't — actually, couldn’t — stop working.

Link of the Week: Toronto Condo Dwellers Flock to Exurbs

Here's a fascinating article about current home ownership and purchasing trends in Southern Ontario. The domino effect appears to be very real. I always love when they point out the behaviour trends of millennials:

Zurini said millennials make up the majority of those leaving Toronto for Hamilton. There, the average house price sat at $662,257 as of the end of the August, according to the Realtors Association of Hamilton-Burlington. The additional interest from Toronto has turned it into one of the hottest markets in Ontario.

Danielle Grant, a sales representative for Hamilton-based Ambitious Realty Advisors describes an environment where buyers must be willing to bid between $50,000 to $100,000 above asking prices and forgo inspections to have a shot at landing a house.

Crazy stuff. If you really want space, there was a place around here for just under $700,000 that came with 10 acres of land.

Where Should I Start?

I'm still a relative newbie in my career, and so the demographic I get to work most closely with is my own demographic: those folks starting out in the earliest stages of their career, in the earliest stages of family life, and in the earliest stages of building wealth. I get hit with these questions more than any others:

Where should I start? How do I start?

I think this is the single, most rewarding question to answer. 

Fortunately, much of the prevailing wisdom about getting off on the right path is good advice. In general, I've found the following steps to work quite well for folks starting out:

  1. Pay off high interest debts.

  2. Save an emergency fund in an easily accessible account.

  3. If you haven't purchased already, save cash for a down payment for a home.

  4. Begin investing in low risk, highly diversified assets. (If you're a parent, invest in RESPs.)

As a whole, I agree with all these steps, but I have a few slightly altered ideas that I'd like to build out over the coming weeks.

This week, Step 1.

Step 1: Pay Off Your Highest Interest Debts

If you're just starting out on this personal finance path, I'm going to imagine you're coming from three different spots (these are the three spots I run into most often in the office):

  • Currently enrolled in post-secondary and want to get started.

  • Finished post-secondary, have begun career, and want to know the best way to get ahead as fast as possible.

  • Finished post-secondary, have begun career, have started a family, and want to know the best way to begin building wealth.

No matter which scenario you find yourself in (and I realize there are many other scenarios one may find themselves in), paying off your highest interest debts first is a must. Usually, those debts rank accordingly from highest to lowest interest rate costs:

  1. Credit card debt.

  2. Personal debt owed to a friend or perhaps a family member.

  3. Unsecured line of credit debt.

  4. Student loan debt.

  5. Secured debt (like a mortgage).

When paying off these debts, I often recommend using the "debt snowball method": Once you've finished paying off a specific debt, take that same payment amount and apply it to the next debt in line on top of the amounts you're already paying on the next debt. So if you have to pay $250 a month to finish off the credit card and are paying $50 a month on the line of credit debt, you should be paying $300 a month on the line of credit once you've finished with the credit card.

This will provide a taste of compounding power early in your financial life and will showcase the possibilities of compounding interest later on in your 50s and 60s.

Credit Cards

Credit cards generally carry a 19%-24% interest rate and are the most debilitating type of debt imaginable. If you have credit card debt and can't find a fast way out of it, open an unsecured line of credit, use the line of credit to pay off the credit card, and focus on private debts owed to family or friends. 

If a line of credit isn't possible, don't be afraid to ask close friends or family for help. In my experience, the least tapped-into social security net are close friends and family. Owing money to family and friends is terrible, but it's not as bad as owing money on a credit card.

In short, cut that credit card debt out as fast as possible. If you're not convinced, take a look at the length of time it'll take to pay off a credit card balance if only a minimum payment is made.

Family and Friend Debts

Once that credit card debt is taken care of, focus on all debts to family and friends. Even if these individuals aren't charging interest on the amounts owed to them, the social cost of having this type of debt hang over your head is worth focusing on immediately after credit card debt. One thing may be coming out of your sibling's or friend's mouth and they may be thinking an entirely different thing about your financial relationship. 

At the very least, determine a payoff schedule with your family member or friend and abide closely to that payoff schedule. Don't miss a payment. Make extra payments before traveling far and wide. 

Again, the social cost of these types of debts are nearly as bad as 19.99% interest rates on credit cards.

Unsecured Line of Credit Debt

These are the types of lending products banks and financial institutions will throw at you after you've been a customer for a few months. You'll often receive a random offer in the mail saying you're pre-approved for a line of credit, and the line off credit will have no security and be based entirely on your annual income.

Usually, these types of lines of credit carry an interest rate anywhere from 6% to 12% in my experience, and they usually hover at the more expensive end of that spectrum. If it's one of the more expensive lines of credit, employ that debt snowball method and knock this thing out.

If you found yourself in credit card debt earlier, these lines of credit are helpful for saving interest costs. Even at 12%, the difference in interest costs from a 19.99% credit card add up significantly in the short-term. 

If you view this unsecured line of credit debt like a credit card, you'll have this unsecured debt gone in no time.

Student Loan Debt and Secured Debt

The sole reason why I'm not a huge proponent of paying off student loan debt earlier in this debt-payoff cycle is because certain types of student loan interest costs provide tax credits in Canada. These credits (and the lack of the mortgage interest deduction here in Canada) often make student loan debt one of the cheapest forms of debt for Canadian post-secondary graduates.

There are two types of student loan debt: those advanced by financial institutions (like Royal Bank or TD Bank or your local credit union) and those advanced by provincial and federal student loan programs (in Manitoba, these are known as Manitoba Student Aid and federal programs in Canada are administered by the National Student Loans Student Centre (NSLSC)). 

Student loans and lines of credit advanced from a financial institution do not result in a tax credit.

Student loans advanced from provincial and federal student loan programs can result in a tax credit.

If you have a student loan advanced from any governmental institution, you'll have to do some math to ensure the after-tax interest cost is less than unsecured lines of credit (or even lower than a mortgage rate, though usually mortgage rates are a bit lower yet than governmental student loan programs). 

In general, I recommend taking 75% of the interest rate quoted on governmental student loans as the real interest cost, as the interest cost results in a 15% federal non-refundable tax credit and around a 10% provincial non-refundable tax credit (25% total). These credits are non-refundable, meaning you'll have to pay tax in a year to receive the credits. But don't worry — you can carry forward the interest costs to a future year to ensure you utilize the non-refundable credit at some point in the future.

So, in easier terms, if you have a 6% interest rate on your $10,000 governmental student loan, I recommend considering it to be more like a 4.5% interest rate. The $600 interest cost can be claimed as a tax credit on your tax return, resulting in about $150 taken off of your federal and provincial income tax bill at the end of the year.

All told, student loans can go a few different ways, and they're not always the wisest thing to pay off first. Payments are usually very low, interest rate costs are low, and the interest costs can often result in a tax credit that you can claim at some point in the future.

Consider Starting Your Emergency Fund and/or Investment Plan in the Middle of Debt payoff

Debt-payoff — specifically high interest rate debts — should be your sole focus until at least credit card debt has been eliminated. But I also wouldn't suggest this is the only path to building wealth either.

If you have kids, for instance, saving money in a Registered Education Savings Plan results in a 20% government grant up to $500 per year. This 20% government grant, plus any interest or investment earnings on the RESP contributions, often amount to a better rate of return than the credit card interest rates you're paying if you're carrying credit card debt. Though I still believe locking in savings at 19.99% by paying down a credit card is wiser, I also can't suggest putting money into an RESP first is a bad idea either.

Once credit card debt is eliminated, I think there's a great deal of wisdom in splitting your payoff efforts between debt and savings. So, if you're applying, say, $500 per month to your debts, consider applying $350 to your debts and $150 to your savings, or a ratio you're comfortable with. Building up an emergency fund (something I'll discuss next week) is an empowering thing, and having cash on hand for both unexpected costs and unexpected opportunities is a tremendous tool in your tool belt.

The same thought process can apply to less expensive debts. You'll see me come back to this return rate quite often, but real estate has grown at an annual rate of 7.1% annually from 1870 to 2015. If you're paying less than 7.1% on your debt, perhaps consider making a real estate purchase instead (if you have access to capital or equity that would allow you to do so).

And near the end of the debt payoff cycle, I have begun to think it's better to begin focusing on that emergency fund or down payment than it is to focus on paying off student loan debt. If your student loan debt is held at a financial institution, then clear up that debt as quickly as possible. But if it's a governmental student loan, take advantage of the tax credit and the long payoff schedule and focus your efforts on building some cash assets in an emergency fund or a down payment fund.

Getting your hands on assets as fast as possible is the key to long-term wealth growth. It's only the most expensive debts that carry a cost greater than asset growth (like real estate or equities) in the long run.


That's part 1 on "Where Should I Start?".

Next week, I'm hoping to discuss saving for emergency funds, why you should save less for your emergency fund than most advice suggests, and why it may be wiser to build your emergency fund and begin investing in other assets at the same time.

Week 3 will be all about saving to purchase a home. And that renting a little longer and buying a bigger house is wiser than jumping into a smaller house just because you don’t want to rent.

And finally, Week 4 will be about building out your portfolio into the stock market. Specifically, I hope to discuss using Wealthsimple Trade and simple ETFs to create your own mutual fund without the expensive fees.

Thank you again for reading this week. Have a great weekend.

JG