As the number of Canadians struggling with unmanageable debt continues to climb each year, attempts to educate the public are becoming more and more important. Again this November, Canadians are celebrating Financial Literacy Month across the country. The aim is to help Canadians improve their financial knowledge and confidence.
In our line of work, as Licensed Insolvency Trustees, we see firsthand the problems created by poor financial management. We work with people of all ages and backgrounds, and we find that false assumptions and a lack of financial management skills are at the root of much hardship.
Of course, we also see debtors who have problems caused by factors completely out of their control – job loss, illness, marriage breakdown. Even in these situations, though, it is the people who have the skills to manage their finances who recover most quickly.
This has gotten me to thinking about how people learn to manage money. Certainly, I learned it through my parents and some difficult personal experiences. I was lucky to have parents who could pass some management skills on to me. Even so, there were gaps in my knowledge.
Life experience is a great teacher, but there is often a huge cost involved in getting that experience. How much better off would most of us be if we hadn’t made those mistakes in our youth.
Here’s a list of what I wish I’d learned in high school, as well as things that many of our clients would have benefited from knowing earlier in life.
The miracle of compound interest. When we are saving money, compound interest is our friend. When we are borrowing money, particularly on credit cards, it is a ferocious enemy. Leaving a balance each month on your credit cards often means that you will ultimately pay over twice as much for the items you purchased.
As your friend, compound interest is what makes saving for retirement a possibility. By putting away a small amount every month, over many years, you can be assured that you will still have a comfortable life after you can no longer work. Your money will have been working for you all those years, adding compound interest and doubling the value of your savings every 8 to 10 years.
The unused portion of your available credit on your line of credit at the bank or your credit card is NOT an asset. It is simply a liability you have not yet incurred. When we look at the amount of credit still available, we can often fool ourselves into thinking that we are in pretty good shape.
Better to focus on the amount owing, and how soon you can pay it off.
The most important step in financial management is keeping track of where you spend your money. People who don’t keep track of their spending are often blissfully unaware of what those “little extras” are really costing.
Would you rather spend your money on that fancy coffee that you buy five days a week, or be able to apply that money towards a family vacation? Every little bit adds up. If Financial Literacy Month does nothing more than teach this simple fact to Canadians, it will have been successful.
Having a budget is not constraining. It is freeing. You no longer have to worry about whether you can afford something if you have budgeted for it. It is best if everyone in the family is aware of the budget and on board with it. It sets a great example for your children. When they know that the family is saving to go to Disney World, or to purchase a new car or a new home, it is easier for them to accept that there are some other things that just don’t fit into the family budget.
Save for big purchases and emergencies, instead of borrowing. This is where the miracle of compound interest comes in. Instead of borrowing and paying the compound interest costs, when you save the money for the purchase, you have compound interest working for you, increasing the amount you save.
Co-signing or guaranteeing a loan for someone else is NOT the same as providing a good character reference. When you co-sign or guarantee someone else’s debt, you are committing yourself to pay the debt, should the primary borrower become unable to make payments.
Lending institutions don’t ask for a co-signer unless they think that the borrower is at risk of defaulting on the loan. Rule of thumb: Never co-sign or guarantee a debt unless you are willing and able to pay that debt in full yourself.
Setting goals is a fundamental of good money management. Like most things in life, you need to know where you are going in order to get there. If you set realistic goals that can be accomplished over time, you are much more likely to be able to stick to a budget and achieve those goals.
It is good to have some less expensive, short term goals, more expensive mid-term goals, and set your most expensive plans as long term goals. Not many years ago, a long term goal would have been ten years. But these days, people change jobs a great deal more than they used to, and five years is about the most anyone can count on without a significant life change.
Some examples of short-term goals (3 – 6 months):
- paying off a high-interest credit card
- saving the damage deposit for a new apartment
- setting aside money for Christmas gifts
- setting aside money for back to school supplies
Some examples of mid-term goals (1 to 2 years):
- Saving a down payment on a new car
- Saving for a vacation
- Sending a child on an overseas school trip
- Paying off all your credit cards
Some examples of long-term goals (3 to 5 years):
- Saving a down payment on a house or condominium
- Saving for that dream vacation of a lifetime
- Getting debt-free (except for your mortgage and car loan)
- Saving for retirement – this goal is usually much longer term than any other.
While your banker is a good source of information, they are not paid to look after your best interests. They are paid to look after the interests of the bank. Because of this, they may encourage you to take the largest mortgage possible, which may not be the best decision for YOU. Before taking on a mortgage of any size, be sure that you have:
- set a budget that allows you to pay the mortgage and maintain a reasonable standard of living
- a secure income to meet the mortgage payments and other family needs
- a plan to meet emergencies.
Purchasing the house is not the only expense in owning one. The maintenance and upkeep need to be part of your budget. Perhaps a smaller home, with a lower mortgage, will give you and your family more financial security.
Many people end up being “house poor” because they overextended financially on their new home, leaving them unable to do all those little extras that make life enjoyable, like eating out or going on vacations.
How to balance or verify my bank accounts each month. This one sounds very simple, but many people have no idea how important it is to examine your monthly bank statements and balance them against your personal record keeping. Only by doing this can you catch items that might have slipped through your expense tracking. It will also let you find errors on your accounts that the bank may have made, or identify any fraudulent transactions.
The house always wins in the long run. Gambling, if controlled, can be a fun activity with friends, but you need to give yourself a hard and fast limit for what you can spend. If you decide you can afford $50 on an evening out, then $50 needs to be the maximum you spend.
Governments use gambling as a form of voluntary taxation. That’s because the house always comes out on top eventually. You may win a small amount, but on average, people lose more than they win.
As Licensed Insolvency Trustees, we generally see people at their lowest point financially. While their situation is often caused by factors beyond their control, their ability to manage their finances gives them a great many more options when it comes to dealing with the crisis. Financial Literacy Month is an attempt to help educate Canadians in those much-needed skills.