The Financial Guide for Post-Secondary Students - continued

Saving and Investments

Who doesn't want to save some money and put that money to work? But it helps if you know how. Here are three basic steps to understanding the investment world.

Step 1: What is your investment profile?

An investment is a place you put your money in order to make more money. To make good investment decisions, start by determining what type of investor you are.

Determine your funds' accessibility (liquidity)

Everyone has different needs regarding getting a hold of their money. It depends on your personal situation. Before choosing the length or type of your investment, ask yourself if: 

• Do I need my money soon? Or later?
• Does my money have to be easily accessible?

If you choose a long-term investment, where you will not touch your money for a long time, you will generally receive a higher interest rate than if you choose a short-term investment. However, if you need the money, you may not be able to have access to it. Think about your options, and especially, get informed!

Determine the level of acceptable risk

Certain investments are very secure, while others represent risks on all levels. The higher the level of risk, the higher your potential return will be. More secure investments generally offer less return but guarantee part or all of your investment. Ask yourself…

• What level of risk can I tolerate?
• What kind of gains am I looking for?

Budget

The amount of money that you can invest partly determines where you can invest it. Certain investments require a minimum amount. Get informed.

Did you know? The savings rates of Canadians dropped from 16.7% of their income before taxes in 1984 to 0.4% in 2004.

Step 2: Save

Why save?

Unfortunately, people are saving less and less, even though savings offer numerous advantages: 

• In case of an emergency, it is essential to have a nest egg. Life is full of surprises (e.g., automobile repairs, loss of employment, unexpected bills, etc.).
• To achieve your financial goals, it is important to plan and to save.
• Thanks to interest, savings allow you to make more money with your money. With loans, you pay to get money.

How to save?

Budget

To save, you must budget. To learn how, consult the Managing Your Money section.

Tips for saving

• Deposit a portion of every pay or allowance in a savings account instead of spending it entirely.
• At the end of each day, put all of your change in a jar and deposit the amount in a savings account once a month.
• Every time you receive unexpected money, deposit a portion in a savings account.
• Consult the Tips on How to Save for more information

Did you know? You must take inflation rates into account before evaluating the real profitability of your investments. For example: if interest rates are at 8% and the inflation rate is 6%, you are only earning 2% before taxes. However, if interest rates are at 5% and the inflation rate is 1%, you will earn 4% before taxes.

Interest rates on Savings

Interest on your savings can be calculated two different ways: simple interest and compound interest. Compound interest is more beneficial. Here's why.

Simple interest

Amount invested × Interest rate × Length of investment (in years) = Amount gained

Example: 

• If you deposit $100 in a savings account with a simple interest rate of 5%, you will gain 5% in interest in the first year.
  $100 × 0.05 = $5
  
• After two years, you will have gained $10.
  
• Your account will continue to increase by $5 per year, regardless of the interest already accumulated.

Compound interest

Interest is paid on the initial amount plus the interest gained.

(Initial amount + Interest gained) × Interest rate × Length of investment = Amount gained.

Example: 

• If you deposit $100 in a savings account with a compound interest rate of 5%, you will gain $5 in interest in the first year.
  $100 × 0.05 × 1 = $5
  
• With the compound interest, you will gain $5.25 in the second year.
  $105 × 0.05 × 1 = $5.25
  $105 + $5.25 = $110.25

Over the long term, compound interest makes a big difference.

Advantages of compound interest
$1,000 investment at different interest rates

Source: CBA — Investing Your Dollar (brochure)

In addition to showing the advantages of compound interest, this chart clearly illustrates the advantages of obtaining high interest rates. Higher interest rates can greatly increase your savings in the long run. However, higher risks are associated with higher interest rates. Shop around!

Step 3: Where to invest

Types of Investments

This chart describes different types of investments. Although it's not complete, this chart is an indication of the different possibilities available to you.

Tips

• The first rule of investing: get informed!
• Start early, and invest regularly even if the amount is very little.
• Make sure to understand the nature of the investment and its inherent risks.
• Evaluate whether or not the investment you are contemplating corresponds with your objectives and with your investment profile.
• Do not feel obligated to make a decision. Beware of sale tactics designed to force you to act hastily.
• Keep statements of all transactions.
• Beware of schemes guaranteeing rapid profit.
• Do not invest based on tips and rumours.
• Diversify your investments.
• Do not forget to review your portfolio regularly. For example, review your portfolio quarterly, every six months or at least once a year to ensure that it still meets your goals.
• If you are saving for a short-term goal like a home, computer or trip, stay away from risky investments that could lead to the partial or total loss of your money.
• When choosing a financial advisor, rely on the recommendations of friends or associates that you trust. You must feel totally at ease with your advisor. Request information on his/her history and the required fees.
• Learn how tax laws affect your investments, to maximize your return after taxes. Ask your financial consultant or accountant to help.

Would you like to know more?

• Get the brochure Investing Your Dollar, published by the Canadian Bankers Association, available free at: www.cba.ca
• Visit the Practical Money Skills Web site at: www.practicalmoneyskills.com
• Use the Daily Spending Calculator on Industry Canada's Office of Consumer Affairs' Web site at: www.consumer.ic.gc.ca/spending
• Take a look at the Investor Education Fund Web site at: www.investored.ca
• Consult your financial institution and do not hesitate to ask questions.

Income Tax

What is income tax?

Income taxes are mandatory payments required from individuals by the government to cover general public interests — the services and goods provided by the government.

Income, such as your wages, is subject to direct tax. Indirect tax is imposed, for example, on the purchase price of goods and services. We will only deal with income tax, because you have a certain control over the application of that tax.

Income tax is imposed on the sum that you earn during the year. A calculated percentage is deducted at every paycheque based on what is believed will be your annual paycheque according to that pay period. For example, if you make $100 per week during the school year, taxes will be deducted from your paycheque based on an annual salary of $5,200. If you have a summer job where you earn $300 per week, you will be taxed as if you earn $15,600 a year.

The government has established certain standards to make the tax system as fair as possible. A rule of proportionality was implemented in order to ensure this fairness. One of the consequences is that we pay income taxes only on revenue exceeding a fixed amount.

What are tax deductions and income tax returns?

A tax deduction reduces the amount of the income that is taxable. For example, the fixed amount mentioned in the previous paragraph is reduced from your taxable income.

By accumulating all your tax deductions and by deducting them from your gross income, you obtain the amount on which you should have been taxed. An income tax return is the amount that exceeds what should have been your contribution. Therefore, it is what the government has to reimburse you.

What does being a student mean for your taxes?

As a student, there are a number of tax deductions available to you. Deductions vary from one province to another. Find out about the deductions available in your region by checking out the Canada Revenue Agency Web Site: www.cra-arc.gc.ca . Here are a few examples of deductions that appear in a number of provinces.

• Tuition fees and textbooks
• Monthly expenses: $400 per month for a full-time student and $200 per month for part-time students.
• Moving fees (when you move at least 40 kilometres closer to your post-secondary institution)

Students often find themselves, without even knowing it, having to make an important choice regarding their finances and savings. At the beginning of every work contract, and every fiscal year, the employer must have its employees fill out a form indicating his/her address and his/her special situation if applicable. In addition, the fixed tax deduction is indicated. Based on this amount, the employee must indicate whether he/she wants taxes deducted from his/her income.

Due to the numerous deductions available and the generally low income of students, some students choose to have no income tax deducted from their income because they figure that the deductions will be large enough that they won't have to pay any income tax for the year. However, if the deductions are not sufficient, the students will have to pay taxes for the tax year by April 30^th of the following year.

The other option is to accept that your income be taxed in accordance with the regular rules and to receive an income tax return (reimbursement) equivalent to your contribution's surplus. In the end, you will have received the same amount of money. The difference is when you receive it. If you have no income tax deducted, you receive your money at every paycheque. If income tax is deducted from every paycheque, you will receive a lump sum in the form of a cheque from the government after the government has processed your tax return.

The following sections will help you compare the advantages and disadvantages of these two options. Like all choices you face as a student, keep your personal situation in mind and make your decisions based on what is best for you.

No income tax deducted

What to do with the money you receive

Necessities

Obviously, if every dollar is budgeted for necessities, it is important to respect your budget. Expenses are predetermined and, once the budget is completed, there are not many choices to make about how money is used.

Investments

Investing is a good way to get a head start on future obligations for those who have more of a long-term plan and are able to invest some surplus income. However, it is important to keep things in perspective. It takes a lot of discipline for a student to take money that is available to him/her and invest it out of his/her immediate reach. Many choose to spend their money having fun. It's okay to have fun. This is part of student life. However, like in all other aspects of student life, you must budget and control these expenses.

This is why the best option, for those who can afford it, is to have income tax deducted from every paycheque and get reimbursed at the end of the year.

Having income tax deducted

Hidden Savings

Don't be under the impression that your “taxes are being taken away” when looking at the amount deducted from every paycheque. Instead, look at it as money going into a “savings account.” It's a way to save without really noticing. As mentioned earlier, this amount will be reimbursed as a lump sum cheque after the government has processed your tax return.

What to do with your income tax return

Of course, you are free to do whatever you please with your income tax return. Students can use their reimbursement in different ways. A survey of post-secondary students revealed some of the ways their personal income tax returns are put to use: 

• Tuition fees and student loans
• Credit card or personal line of credit
• Investment
• Purchases: trip, car, etc.

It is up to you how to determine the best way to spend these “hidden savings.” Keep your needs and wishes in mind. Satisfy your needs first, then your wishes.

Beware of working “under the table”

Working under the table is when someone performs work without declaring his or her earnings, so there are no tax deductions. The Canadian income tax system relies on self-assessment, meaning that taxpayers are responsible for declaring their own income. Some people choose not to declare income that would otherwise be taxable. The government taxes the income of citizens in order to ensure the well-being of the population as a whole by providing them with essential services (e.g. police and fire services), adequate infrastructure (e.g. bridges, streets) and assistance to those in need (e.g. employment and welfare benefits). By choosing not to pay their share of taxes, people increase the financial burden that the rest of the population is left to bear while they take advantage of benefits offered by the government. In some ways, working under the table steals financial resources that should normally be redistributed to society.

What Type of Credit is Best for You?

There are now many different ways to borrow money. Study the different options in order to choose which one best suits your needs. This section will give you an overview of these options.

Some economic terms before starting

This section contains some basic terms that you must absolutely know in order to come to grips with your financial situation. Understanding interest and inflation will allow you to maximize your money.

What is interest? What is the rate of interest?

Interest is the cost of money. The rate of interest is the cost of using someone else's money. When it comes to interest rates, Canadians are pulled in two directions: people who save and invest their money expect a good return, while those who borrow money to buy homes, a car, or a business want the lowest possible interest rates. In other words, we are looking for the best of both worlds.

I'm shopping for a loan.
What factors might affect the interest rate I will receive?

Term of the loan:  This can have an important bearing on the interest rate you'll pay. First of all, rates vary for short- and long-term loans. Short-term loans — which vary from a day to a year — carry a lower interest rate because it is easier for the lender to predict future market conditions such as inflation and economic growth. Lenders tend to charge higher interest rates on long-term loans because they are taking a risk on future economic conditions. If they do no protect themselves against possible increasing interest rates set by the Bank of Canada, they could lose money on the long-term loan.

Risk:  The more lenders expose themselves to risks (that is, the likelihood that the loan will not be repaid), the more they will require higher interest rates to compensate. They will ask you:

• What is your credit rating? Your credit rating is created as soon as you receive credit or apply for credit. Lending companies and credit card companies regularly send financial information to credit rating agencies about your credit transactions. These agencies compile this data, to be able to consult it in the future with your authorization. Your credit file is a history of your finances and your performance with respect to creditors. You receive a rating based on this history.
  
  You should request a copy of your credit file once a year to make sure that there is no mistake on your credit report. To request a copy of your credit report, contact the following credit-report agencies: Equifax Canada Inc ( www.equifax.ca ), Trans Union Canada ( www.tuc.ca ) and Northern Credit Bureau ( www.creditbureau.ca ).
  
  If you find an error or some inaccuracies on your credit report, you can contact the organization that provided the incorrect information and ask that they correct the error. If they refuse, ask about their complaint handling process if you want to contest their decision or call the Financial Consumer Agency of Canada toll free at 1-866-461-3222.
  
  
• What is your past record of borrowing and repayment?
  
  
• Have you always made your payments on time — including credit cards?

Inflation:  This relates to the lender's concern with the change in the level of prices that may lie ahead. A general increase in prices across the economy is called inflation. That means that the same amount of money will be able to buy less. In other words, the purchasing power of money is reduced. For example, if a financial institution loans you $2,000 today and prices increase by 5% over the next year, the purchasing power of that $2,000 will be less when comes time to repay it a year later. In essence, you will be repaying cheaper dollars than the ones you borrowed. Lenders, therefore, build a assumed inflation rate into the interest rate you will pay.

You cannot influence some of the above factors. But it is an asset if you have a good credit rating.

How can I get the lowest rate of interest?

• Shop around to find the best rate for your needs.
• Do not be afraid to ask for a lower rate than is quoted. Remember that the posted loan rates are only guidelines. Your mortgage may provide your best opportunity for bargaining because it is a secured loan.
• If you are not happy with the rate your financial institution quoted, check around to see what other lenders are offering. Your alternatives include banks, trust companies, credit unions, caisses populaires, mortgage loan companies and government lending institutions.
• Maintain a good credit rating — pay back your debts and pay them on time. This could give you additional leverage when negotiating a loan.

Student loans

Student loans can be granted by governments or by financial institutions.

Possible benefits of a student loan

• Allows you to continue post-secondary studies.
• The government pays the interest on your loan while you are studying full-time. You repay the loan upon completion of your studies. The interest on your loan starts when you cease to be a full-time student.

Potential risks of a student loan

• At the end of your studies, you may have to deal with substantial study debts. This may delay other plans, such as travelling or buying a house.

Credit cards

Generally, credit cards allow you to make purchases, up to a specific credit limit, for which you will be billed at a later date. They allow you to transfer your balance from one billing cycle to another. Nevertheless, you must pay a minimum amount every month, and unpaid balances are subject to interest charges, based on an annual percentage rate or APR.

Possible benefits of a credit card

• Helps you create a credit history and earn a credit rating.
• Can be more practical than carrying cash.
• Allows you to borrow free of charge if you always pay the balance in full by the due date.
• Can offer incentives, such as reward points that you can use towards purchasing certain products.
• Allows you to pay conveniently for purchases made over the telephone or on the Internet.

Potential risks of a credit card

• Can lead you to spend more and drive you into more debt than you can handle.
• Can affect your credit rating if your monthly payments are late.
• Can carry conditions that are hard to understand.
• Is generally more expensive than other forms of credit like personal lines of credit or personal loans.

Which credit card best meets your needs?

Credit limits, annual fees, interest rates, grace periods and reward programs are some of the many factors that come into play in terms of credit card shopping. Some financial institutions also provide lower-rate and regular-rate credit cards specifically designed for students. The bottom line is that you should take time to shop around in order to choose a card that best suits your needs.

Credit Cards and You, from the Financial Consumer Agency of Canada (FCAC), compares over 200 credit cards in circulation in Canada in terms of interest rates, service fees, as well as reward and protection programs. Also included are tips on how to save money, on how to protect yourself against credit card fraud and how to get the most out of your credit card.

You can find Credit Cards and You on the FCAC Web site: www.fcac-acfc.gc.ca . Or receive a free hard copy of this publication by calling the FCAC, free of charge, at: 1-866-461-3222.

Personal line of credit

Provided by financial institutions, this type of loan allows you to withdraw money, as needed, up to a maximum credit limit. You are charged interest from the day you withdraw money from your line of credit until you pay back the loan in full. The interest rate on a line of credit is usually lower than the interest rate applied for cash advances on a credit card.

Possible benefits of a personal line of credit

• Gives you the convenience of borrowing money whenever you need it: you do not have to reapply for loans.
• Offers flexible reimbursement methods.
• Offers lower interest rates than credit cards.

Potential risks of a personal line of credit

• Some people use this loan as a source of revenue.
• Can force someone into more debt than he/she can afford.

Personal loans

You can get a personal loan to buy a car, to buy furniture, to go on a trip, etc. You then use the borrowed amount as you wish. The amount, the rate and the conditions of reimbursement are fixed at the time of the contract. A personal loan is reimbursable in a predetermined time frame through monthly payments.

Possible benefits of a personal loan

• There are various options that allow you to obtain a loan to meet your needs.
• The loan is negotiable.
• You use the borrowed amounts as you wish.

Potential risks of a personal loan

• Since this loan is not linked to a specific purchase, if the goods are defective or if there is any other problem (e.g. the goods are not delivered), the loan must still be reimbursed.
• Can drive you into more debt than you are able to pay back if the loaned amount does not take into account your ability to repay.
• Increases your monthly obligations.

Instalment plans

Instalment plans normally apply when you make a significant purchase at a business. For example, you may purchase a television or a refrigerator but pay for it through monthly instalments, usually accompanied by a certain interest rate.

For this type of contract, the seller has ownership of the goods until they are paid in full, even though you are in possession of them. Therefore, if you miss a payment, the seller can demand that the goods be returned. Remember that in this type of contract, the merchant is responsible for accidental loss of the goods as long as you are not yet the owner.

Possible benefits of instalment plans

• The merchant is responsible for accidental loss of the goods as long as he/she is still the owner.

Potential risks of instalment plans

• They increase the total price due to the interest charges.
• The seller remains the owner of the goods until they are fully paid.
• They increase your monthly obligations.

Beware of “buy now, pay later” promotions

Several stores offer this type of promotion. You buy goods today, but pay nothing for one year, for example. This kind of advertisement usually does not indicate the consequences of not making payments on time. In fact, according to some store policies, interest starts to accrue on the date of purchase. This interest is cancelled if the person pays within the time limit. However, if someone pays after the time limit, he or she must pay interest for the whole period and interest rates are usually quite high!

For example: 

• You buy electronic equipment worth $1,000.
• You do not pay within the one-year limit.
• The interest rate is 28.8%.

You will have to pay $1,000 plus the year's accrued interest. In addition, people who resort to this sort of agreement often do not have the means to pay off the goods at the time of purchase, nor do they have the means to do so in one year. Many possible events can change your financial status over such a long period of time, so be careful.

Mortgage

A mortgage is a long-term loan granted to an individual in order to buy a home. The home itself is given as a guarantee for the loan. There are different types of mortgage loans, such as open or closed, that offer variable of fixed rates and various options concerning the term, the payment frequency and the amortization period.

Possible benefits of a mortgage

• Allows you to purchase a home, which would be impossible without a loan.
• Offers favourable rates.

Potential risks of a mortgage

• Monthly payments are sometimes high.
• Because it is a long-term purchase, a change in household revenue could have a negative effect on your ability to pay it back.
• The home is given as a guarantee of the loan, meaning that in case of a nonpayment the home could be taken.
• The purchased property can easily cost double because of interest.

Would you like to know more?

• Consult the Managing Your Money brochure, published by the Canadian Bankers Association. It is available at no charge at: www.cba.ca
• Take a look at the Cost of Borrowing Calculator on Industry Canada's Office of Consumer Affairs' Web site at: www.consumer.ic.gc.ca/spending
• Use the Credit Card Costs Calculator at: www.consumer.ic.gc.ca/credit
• To choose the appropriate credit card, visit the Financial Consumer Agency of Canada at: www.fcac-acfc.gc.ca/fra/publications/ccc/0104/default_PDF.asp
• Consult your financial institution and ask questions! You can, among other things, get information about current interest rates depending on the loan type.
• The Financial Consumer Agency of Canada has developed mortgage loan-related tools such as a publication entitled ABCs of Mortgages, a calculator and a quizz. See the FCAC Web site: www.fcac-acfc.gc.ca. You may also receive a free hard copy of ABCs of Mortgages by calling the FCAC free of charge at: 1-866-461-3222.