Canadian $100 bills falling from the sky.Jean-Guy Lavoie/Getty Images/iStockphoto
Investing Exchange brings couples together with financial advisers in an exchange of opinion over saving and investment strategies.
In this exchange, we meet a Toronto couple in their 30s who recently got big boosts to their income. But Mike and James have different ideas on what to do with the raise and bonus: Renovate to increase their home's value? Pay off debt? Get serious about RRSPs? With a combined income of $285,000 and debt of $675,000 and little in retirement savings, they need a path forward.
Their dedication to their careers earned Mike and James each a big pay boost – a total of tens of thousands of dollars that has created financial opportunities for the couple, but also some investing stress.
Mike, 32, is in marketing, and with his $25,000 raise is now making $90,000 a year. James, 36, works for a consulting and communications firm, and earned a $50,000 bonus that he'll get every year, raising his pay to $195,000 – so together they gross $285,000 annually.
But the Toronto couple is at a standstill over what to do with that $75,000 in raise and bonus money this year: Should they pay off debt (totalling about $675,000), or use it to work toward their housing, family and retirement dreams?
Mike and James (who preferred their real names not be used) share a home in the historic Cabbagetown area of the city and have much in common, but admit they sometimes handle money differently. So to help set them on a path, they turned to financial coach David Campbell Lester, also a personal finance writer with the blog I (Heart) Money, and author of a book by the same name, as well as his latest book, From Middle Class to Millionaire.
"Having David forced us to talk about things," Mike says.
What they realized is James, especially, tends to be more of a spender.
"Both Mike and I have good incomes and I've always felt like, 'I'll deal with debt later on,' so every time I get a raise or bonus, I find ways to spend that," James says.
Although both admit they were in a bad spending cycle, Mike says he is more careful with his credit cards than James. Together, they racked up $25,000 in credit card debt, with $50,000 owing on their two lines of credit (LOC) – paying interest alone of about $6,750 a year on rates of between 5.85 and 19.9 per cent. Altogether, they were paying about $9,000 a year in interest.
It seemed simple to just put that $75,000 in bonus and raise money this year right to paying off their credit card and LOC balances.
But they had some goals in mind to invest toward, as well. James, for instance, has expressed interest in renovating the front yard, the upstairs loft, the deck and the closets of their home to make it more appropriate for entertaining, and to increase its market value – now at about $900,000.
As for the more distant future, they have been thinking about possibly starting a family, and how they will fund their retirement. Before seeking Mr. Lester's help, the couple didn't have significant emergency savings or Registered Retirement Savings Plans – James had no RRSPs, while Mike was contributing $100 a month and had only $3,000 in his plan.
Mike and James had also consolidated their debt twice, including two years ago when they renegotiated their mortgage, which is now at $600,000 on 2.9-per-cent interest over five years. But the spending did not stop. Besides enjoying vacations and nice clothes, they had to do work on their home, including repairing the roof with two skylights at a $20,000 cost.
Mr. Lester, president of DCL Capital, says many couples get into a bad habit of piling debt on debt.
In helping clients with the financial plans (he also works with a portfolio manager who handles their investments), Mr. Lester examines their belief systems surrounding money.
"And when you dig into the belief systems, that's where you figure out why, say, James is the way he is and how he treats money, and Mike is the way he is and how he treats money, and also how they see their future, taking into account what they want and why they want those things, and how to use money as a fuel to work towards reaching your goals."
In working with Mike and James – such as asking them what they really want immediately and ultimately, and assessing the steps they need to take to make it happen – Mr. Lester learned that, beyond the pair's desire to pay down debt, renovate their house and build their savings, they wanted to buy a cottage or farmhouse as a second property.
After reviewing the goals, assets and liabilities of Mike and James, Mr. Lester believes he has come up with a plan that will help the two pay off their debt in 10 years, and allow them to reach their investing, retirement, and home renovation and second-residence goals, without too many sacrifices. The couple is already following much of this advice:
1. They will get a homeowner line of credit, which is secured by the equity in their home, for $75,000, to consolidate all the credit card and LOC debt, and close the high-interest cards and LOCs. Consolidating will save the couple $6,750 a year, by bringing the interest rates down to 3 per cent from the current 5.85 to 19.9 per cent they are paying.
2. James started an RRSP with that first $50,000 bonus, and plans to use future bonuses to max out his contributions each year. Mike is now adding $800 a month (which will total $9,600 a year) to his RRSP portfolio – and has already gone from $3,000 to $10,000. Both have balanced portfolios consisting of short-term corporate bond funds, and big blue-chip U.S. and Canadian dividend stock mutual funds.
3. They are increasing their home mortgage payments from $3,200 to $6,500 a month.
4. They will put their income tax refunds into tax-free savings accounts, and use future tax return refunds to max out their unused TFSA portions – to save for a rainy day, and possibly for that cottage.
5. Mike and James each get $2,000 in cash for personal spending on whatever they want – so they don't start piling up credit card debt again. "When it is gone, it is gone!" Mr. Lester says.
The couple feels the plan is doable, even over the long term.
Mike says, "Even when you break it down, we're still able to have a good amount of entertainment money on a monthly basis, so I don't think we will feel we will have to change our lifestyles. … It's all about communication and being on the same page with your goals and aspirations, and thinking about your future and how you want to get where you want to be – at an early age."