Financial literacy can help raise intelligent, informed, and confident children who can make solid and thoughtful decisions about the wealth they will inherit and/or build over their lives. Here are five foundational building blocks to help your children and beneficiaries become confident and sound financial managers.
“Money doesn’t grow on trees!”
Many of us have heard those same words in one form or another at some point in our lives – hopefully in our younger years. Like many truisms of the financial world – including “Don’t put all your eggs in one basket!” and “Slow and steady wins the investing race!” – “Money doesn’t grow on trees!” captures a hard truth of life: money must be earned.
But earning it is only one part of the financial success equation. The other is keeping it, and, if we are smart about it, growing it and making it work for us. Financial literacy is important because it empowers us to make smart decisions when building and growing our wealth – and helps us avoid costly mistakes, too, which can be devastating over the long term. Financial literacy also leads to greater resilience during predictable and unpredictable life events. Learning how to earn, spend, save and invest wisely contributes to overall well-being and stability – and provides a solid foundation to long-term financial well-being.
Five financial foundations of success
Here are five “building blocks” to help ensure your kids and/or beneficiaries (or even you) are prepared for the financial challenges and opportunities of the future:
1. Budget your money
A great financial “rule of thumb” is “Pay yourself first” – meaning, make sure to set aside funds towards your savings goals, along with paying your expenses. In general, there are four main uses for money: spending, saving, investing, and giving away. Finding the right balance among these four categories is essential, and a budget can be an especially useful tool to help you accomplish this.
An important starting point in creating a budget is thinking about and recording your short- and long-term financial goals (e.g., a new electronic device, vacation, vehicle, house, further education). Doing so will help generate a baseline for mapping out and putting concrete plans in place.
Remember this formula: Income – expenses = savings
Savings, however, should never be an afterthought, and instead should really be seen as part of your expenses. To help prioritize savings in your budget, consider setting aside a specific amount on a regular basis, such as through a pre-authorized contribution plan where funds are taken from your account on set days and deposited in an investment vehicle or savings plan.
2. Be aware of taxation
Taxes are an inevitable part of our lives and have an important impact on our financial well-being. It is important to understand your true earnings and how they are taxed. In general, there are four main sources of income: employment or business income, investments, inheritance and unexpected (such as a lottery win). Each of these sources may be taxed in different ways and at different levels. Canada's federal tax rates are based on income level. You can find the current and previous income tax rates for individuals on the Government of Canada’s Canada Revenue Agency (CRA) website.
Remember: it’s not necessarily what you earn that matters, but what you keep – after taxes and other expenses – that really tells you what you have netted.
3. Borrow to grow, not to consume
There are lots of reasons we borrow, including:
- To help build credit history for future needs (such as a mortgage)
- To satisfy short-term purchasing needs or online payments (vacations, gifts, personal and household items)
- To facilitate longer-term goals (purchasing a car or house or paying for education)
Debt can be a wonderful way of helping to build wealth, so long as you can pay the borrowed funds back. To avoid over-indebtedness, it is crucial to ensure funds are available to pay your bills. Planning goes a long way to help stay on top of debt. Try creating a list of all your outstanding credit and write down when payments are due and what the interest rate is for each. A good general rule is to repay the debt with the highest interest rate first, and always try to determine where you can make more than the minimum monthly payment.
4. Plan before investing
Identifying your short- and long-term financial goals will help determine which types of investments and planning approaches may be most suitable and effective to help you save for your needs. In doing so, it is crucial to first distinguish between what you actually need versus what is “nice to have.” Going through this process allows you to set realistic goals that you can confidently work towards achieving.
Whether you develop a simple wealth projection or a more detailed wealth plan, the process involves analyzing and interpreting all your financial information. From there, results are generated, and those results are modified and tweaked until desired goals become feasible. Your current stage in life may impact what type of recommendations are made, as well as how you implement the recommendations to pursue your financial goals, and will differ by individual (e.g., increase savings towards your retirement goal by opening a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP)).
5. Invest to achieve your goals
Once you know your budget, you have your goals established, and you have a plan to guide you to achieving those goals, investing is the next stage of financial success. While there is a wide variety of investment options available, the two primary types of accounts in which they are held—registered and non-registered—can have implications for investors:
Registered: Accounts and plans that are registered with the government for income tax purposes and that provide tax-deferral opportunities (e.g., RRSP, Registered Retirement Income Fund (RRIF), Registered Education Savings Plan (RESP), Registered Disability Savings Plan (RDSP), other pension plans) or are non-taxable (TFSA, First Home Savings Account (FHSA)).
Non-registered: Accounts that are not registered with the federal government, do not have limits, and earn income that must be included as taxable income each year (e.g., Investment accounts with corporate stocks, bonds, mutual funds, exchange traded funds (ETFs) or guaranteed income certificates, to name a few).
When it comes to investments themselves, there is a difference between an asset class and an investment vehicle, as follows:
- An asset class is a broad category of investments (e.g. cash, bonds or stocks) that have a distinct risk/return relationship
- An investment vehicle is the financial product that enables investors to buy and sell the underlying asset class (e.g., a mutual fund or an ETF).
Finally, it is important to understand the relationship between risk and return. In the investing world, there is a strong relationship (correlation) between risk and return. Generally speaking, the higher the potential return, the more risk an investor should be willing to accept. Keep in mind, for most types of investments, returns are not guaranteed.
We can help
Financial literacy and implementing the five basic foundations to long-term financial success is an ongoing learning process, and the above overviews are not exhaustive. Over time, one will learn much about themselves as a saver, spender, borrower and investor, all of which will help them to hone their own awareness and what makes the most sense for them and their life.
Most importantly, knowledge is power, and the more knowledge they have, the smarter their financial decisions are likely to be – and the greater likelihood they will achieve what matters to them in their life.
If you have questions or want to learn more about financial literacy, contact your advisor.
This information is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy. This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / TM Trademark(s) of Royal Bank of Canada. Used under license.