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Money Management 101

February 27, 2011

$100,000According to the Vanier Institute of the Family (an Ottawa-based ‘think tank’ that regularly reviews the state of Canadian families), the debt load of the average family (earning about $68,000 after taxes) has reached an all-time high of $100,000.  Their savings, on the other hand, are something like $2,500.  The average debt-to-income ratio is also at its highest ever – 150% (which means for every $1,000 of after tax income, the ‘average’ Canadian owes $1,500).  This puts Canada at the top (where ‘worst’ gets you a #1 rating) with respect to personal debt in the developed world (but, hey, it puts us on equal footing with the Americans! Now there’s something to be proud of!) 

Carrying DebtFamily debt has risen 78% over the past twenty years, yet savings have dropped from 13% of our income (in 1990) to approximately 4% (in 2010).  Families are taking on larger mortgages, buying more expensive cars, and charging more on various credit cards (it is estimated that the average Canadian has no fewer than FIVE different credit cards!)  At the same time, fewer families than ever before are investing in RESPs and RRSPs, corporate pension plans are scaling back on benefits (and only about 25% of Canadian even have a company-based pension plan).  This means we’ve got an entire generation that will have to finance their children’s post-secondary education through (more) loans and – when they reach 65 – rely on meagre personal savings and the less-than-adequate government-sponsored Canada Pension Plan (‘average’ payout: $25,000 annually) to live. 

It has been suggested that the ‘average’ couple will need $1,000,000 (yes, that’s ONE MILLION DOLLARS) in savings, investments or equity (i.e., a mortgage-free home and no outstanding loans or other debt) in order to maintain a ‘comfortable’ lifestyle (similar to how they’re used to living) for 25 years after retirement (NOTE: this is ON TOP OF monthly income from government-based pension plans).  Of course, they’ll need more if they plan to travel or undertake other expensive ‘hobbies’. It’s estimated than fewer than 10% of Canadians will be in this position when they reach 65 – mostly because they are spending (or should I say ‘owing’) far more than they are earning.

How did we get ourselves into this mess? 

Mass ConsumptionThe answer is actually pretty simple – we spent ourselves there!  We bought things we couldn’t afford (from houses, to cars, to furniture, clothing and ‘trinkets’) – and generally didn’t need.  Post-war mass production and its cousin, mass marketing, convinced us that we had to have the latest, greatest products, gadgets and goo-gahs –  and that ‘keeping up with the Jones’s’ was vital to our happiness (not to mention our status in those lovely new suburban neighbourhoods that were springing up everywhere).   And buy we did!  As the job market moved from the country to the city, salaries increased, and women entered the job market, families had more dollars to spend on more products, and more space to put the stuff they bought.  However, with the exception of mortgages on those lovely new three-bedroom bungalows and four bedroom two-storeys, spending was generally geared to income. Credit was exceedingly hard to come by for the ‘average’ Canadian.  You earned your paycheque, deposited it in the bank, and took out cash (or wrote cheques) for expenses. Mortgages were granted to a maximum of 25% of income. Basically, if you didn’t have the money, you didn’t buy the goods or get the loan.  It was actually quite difficult to get into (too much) debt.

But things have changed significantly in the past forty years. First, due to any number of circumstances related to the economy, the cost of living has increased 457%. That’s pretty scary on its own.  The amount we pay in total taxes (income, property, HST, fuel surcharges, etc.) has risen from 35% of our income in 1970 to 50% in 2010.  In order to keep the housing market ‘booming’, banks are willing to grant mortgages for up to 50% of net income.  The result is that while salaries have risen dramatically, we have a lot less ‘disposable’ income than ever before. And the bigger problem is that we keep ‘disposing’ of more of it than we earn.  For some reason, people today seem to think they can’t live without all the ‘stuff’ that’s being manufactured, marketed, and sold, whether they can afford it or not.

Credit CardsProbably the biggest ‘villain’ in this story is the credit card. Before 1980, they simply weren’t popular with consumers because few companies accepted them (whereas cheques were almost universally accepted), and service charges were in the 5% to 7% range. They simply weren’t practical.  It wasn’t until 1980 – when banks took over the issuing of cards and the responsibility for processing payments – that their numbers increased.  In fact, the number of credit cards issued doubled between 1980 and 1990, and amounts charged to them more than quadrupled (from $518 in 1980 to $2,700 in 1990; today, the ‘average’ person carries a balance of $7,500 on their credit cards).  And its easier than ever before to get one – you don’t even need a credit rating (banks actually set up tables in the hallways at Colleges during the first few weeks of September; the majority of young people sign up for their first credit card during this ‘blitz’; few understand the implications of 18% interest on amounts not paid at the end of the month, however, and most default within two years).

Now, I’m not a licensed financial planner; in fact, I’ve never taken a financial planning course or studied the subject beyond reading a few books on my own, following the personal finance section in the newspaper, teaching basic financial management concepts to first year business students at College, and using what my dear old Dad called ‘good old fashioned common sense’.  But I have never been in debt (outside of mortgages on my homes, and two unavoidable-at-the-time car loans – all of which I paid off early to save interest charges), so I feel somewhat qualified to offer the following advice on how to stay out of debt.

  1. Spend only what you have.  This is the simplest of all the ‘rules’.  If you don’t have the money in your pocket (or in the bank) for whatever it is you’re thinking of buying – DON’T BUY IT. You can’t afford it.  This is one of the earliest lessons my father taught me, and he was right.  The easiest way to follow this rule is to use cash or a debit card for all purchases. (NOTE: research shows that people who buy ‘stuff’ with a credit card spend twice as much as those who buy with cash/debit!)
  2. Pay Off Credit CardsPay off credit cards in full every month. If you choose to use a credit card for larger or – say, online – purchases, charge only what you can afford and pay it off in full at the end of the month.  The easiest way to do this is to arrange an automatic payment plan with the bank (NOTE: regularly paying your credit card IN FULL also gives you a good credit rating, which will help when/if you need to get a car loan or a mortgage).  Remember, too, if you don’t pay the balance in full, you will be charged interest on the ORIGINAL BALANCE, no matter how much (or how little) you’ve already paid. And, as for those ‘minimum payment’ amounts – they are deadly! Here’s why – let’s say you see a big screen TV and surround sound system that you simply can’t live without for $2,000.  You don’t have the money, but you do have a credit card and you figure you can easily pay the minimum monthly payment.  But – if you buy NOTHING ELSE on that card – here’s what that $2,000 worth of electronics will end up costing you (I’m presenting two scenarios here, based on two popular card payment types – do you know which type YOU have in your wallet?)
    • Using a credit card that charges 19% interest and requires 2% minimum payment per month, it will take you 265 months (more than 22 years) and cost almost $4,800 in interest to pay offThat $2,000 system will end up costing you $6,800 (and you’ll have gotten rid of it long before you’ve finished paying for it!)
    • Using a card charging 18.5% with a minimum payment of $20 per month, it will take you more than11 years and cost you $1,934 in interest to pay off.  You’ve just doubled the purchase price (and, again, I bet the system won’t satisfy you for 11 years, either!)
  3. Compare loan rates. Remember that when you use a credit card you are actually borrowing money from the bank at exorbitant interest rates. If you really need to make a larger purchase and you don’t have cash on hand, consider a personal loan or a line of credit instead of using a credit card. You will likely save hundreds or thousands of dollars in interest.
  4.  Buy stuff on sale.  Almost every item available in every retail environment goes on sale at one time or another.  I can honestly say I have never paid full price for anything in my life.  I shop the bargain racks, ‘scratch-and-dent’ sections, after-Christmas, and end-of-season sales and I keep an eye out for discounts and sales on items I need (NOTE: not ‘want’, but ‘need’ – there is a HUGE difference between these two words!)  I know people with generous incomes who shop in consignment, second-hand, and thrift stores just to save a few dollars (which they can then spend on other things, or invest in savings or retirement plans). 
  5. Money spent costs you the time it took to earn it.  Whenever you are tempted to buy something, consider how much time it will take you to earn the money to pay for it. For example, if you make $15.00 an hour, your take home is about $10.00.  An $80 concert ticket or jacket (or whatever) will ‘cost’ you eight hours of work time. Is it worth it?
  6. Save and BudgetLive within your means .  Spend less than you make. This assures that you will always be ‘in the black’, have some extra money to save/invest, and avoid debt-related issues.  Create a budget and stick to it.
  7. Pay yourself first. Include self-payment in your budget and prioritize it so that it is as important as your rent or mortgage or other expenses. Even if it’s only a dollar a week, put some money away and let it grow.  If you start saving in your twenties, you can have $1,000,000 in the bank by the time you retire.
  8. Pay down mortgages, loans, etc. Few people understand the difference making extra regular payments (i.e., every two weeks vs. monthly) or lump sum payments has on the total cost of a mortgage or other loan.  Let’s say you have a $150,000 mortgage at 5% interest, amortized over 25 years, with standard monthly payments of $875.00. You’ll pay $113,000 in total interest on that loan.  However, if you make payments every two weeks (instead of monthly), you’ll pay $404 every two weeks but save $11,000 in interest.  If you can manage an extra $100 a month, your total interest drops to $72,000 (that’s a saving of $50,000).  The more you pay off early, the more you save in the end. Any time you have a little ‘extra’ cash, paying down the mortgage is the smart thing to do.

Unfortunately I can’t advise on how to get out of debt if you’re already there (except to say this – ditch the credit cards and learn to spend less!) However, I do know that most banks offer free financial planning advice and that there are organizations and social services agencies that can provide help for those who can’t pay their monthly bills and/or who need help balancing a budget.  But if you are just starting out in life – or you know someone who is – please pass the advice above along to them. The earlier someone recognizes the relationship between income and spending – and debt – the better! 

There is – in my mind – absolutely, positively no excuse for people to be in the kind of debt they are in.  It’s self-inflicted injury.  Cut back, pare down, buy only what you need, don’t live beyond your means, save whatever you can and plan for the future – and you, too, can be living debt free when you reach … the other side of 55.

Living Debt Free

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2 Comments
  1. March 4, 2011 10:14 pm

    hi margo,
    we met at CJ’s in Oakville.
    CONGRATULATIONS!!!
    i saw your BPL winning story in the post.
    loved it. gave me a good laugh.
    keep up the great work.
    jennifer

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