George, who lives with his mother in a townhouse, wants to open a wine bar. To get a leg up given his modest income, he is looking to speculate in real estate.Glenn Lowson for The Globe and Mail
George has the lofty goals and dreams befitting a budding entrepreneur: He wants a business of his own, easy money, and the freedom wealth brings to put up his feet and retire by the time he is 55 – with an income of $150,000 a year after tax.
Back down on earth, George is 23, recently graduated from university and has just landed his first "real" job earning $35,000 a year plus bonus and other benefits. He lives with his mother in a townhouse in the Guelph area that they plan to flip for a $60,000 profit. He wonders how best to use his share of the anticipated gain.
George's big dream is to open his own wine bar. He aims to save $70,000 over the next 10 years as a down payment and wonders whether that will be enough to enable him to get the financing he will need. To get a leg up given his modest income, he is looking to speculate in real estate.
"Since I want to open a wine bar one day, I figured house-flipping was one way to jump-start a savings plan at the beginning of my career, when the money is still tight," he writes in an e-mail. Mind you, that $60,000 profit he and his mother expect has yet to be realized, and they'd need at least half of it as a down payment to buy a bigger, better home.
George also wonders how best to save for retirement – a concern that seems premature given the number of events that could come along and turn his plans upside down, marriage being just one. In a few years, when his income is higher, he hopes to buy a house of his own, which will increase his expenses dramatically.
We asked Kurt Rosentreter, a senior financial adviser at Manulife Securities Inc. in Toronto and author of Wealthbuilding, to look at George's situation.
What the expert says
First, the house. "Don't sell it," Mr. Rosentreter says. "The land-transfer tax and legal fees erode value. Stay and renovate." As for house-flipping as a way of making money, "Be careful. A real estate correction in the future could leave this ending badly for a young guy with not a lot of wiggle room."
George is carrying a credit card balance, a student loan and a car loan. He should make paying these debts off a priority, the planner says.
For his retirement savings, George may want to put off contributing to a registered retirement savings plan until his income is higher and he can get a better tax break. Instead, he can save money to start his business by contributing the maximum each year to a tax-free savings account, with any surplus going to a non-registered investment account. With a 10-year time horizon to save for the wine bar, he could take some stock market risk, investing in a no-load, low-cost balanced mutual fund and/or an emerging market exchange-traded fund, Mr. Rosentreter says.
To get a firm grasp on what is required to open a wine bar, George could talk to one or two people who own one to see how much it will cost to start up, the planner says. "Set annual targets for saving a base amount that lenders would require to take you seriously," adding that $50,000 to $100,000 is likely a solid base to work from. How much money George is ultimately able to borrow will depend on his income at the time and the business case for the venture, Mr. Rosentreter says. "The more money he has saved, the easier it will be to get off the ground."
The planner looked at what would be needed for George to achieve his ambitious retirement income goal. George asked that the calculations be based on his retiring at age 55 and living to age 80. To get $150,000 a year after-tax, George would need $200,000 before tax, $20,000 of which would come from future Canada Pension Plan payments (CPP is indexed for inflation).
Mr. Rosentreter says George would need to accumulate $2.5-million by the time he is 55, excluding his home. Assuming a 5-per-cent rate of return on his investments and a 32-year time horizon, he would have to save $33,000 a year to achieve his goal, so he may want to set his sights a little lower. Mr. Rosentreter's suggestion: "Save what you can."
Client situation
The person George, 23
The problem How to save enough money to open his own wine bar in 10 years, given his modest salary.
The plan Be careful about trying to make a quick buck flipping houses. Instead, save what he can, starting with his TFSA and then, when his income is higher, through his RRSP. Talk to wine bar owners for information on startup costs and financing.
The payoff A plan for the future guided by realistic expectations with no unnecessary risks.
Monthly net income $2,345
Assets Residence $160,000, George's share $80,000; RRSP, TFSA, other savings $3,200. Total: $83,200.
Monthly disbursements Share of mortgage $257; utilities, home insurance $224; auto insurance $199 (gas, parking, maintenance paid for by employer); food $100 (he gets a meal allowance at work, his mother picks up most of the bill at home); vacations $0; gifts $0; life, disability insurance $0; telecom $90; car loan $331; student loan $252; credit card $22; dining out $150; entertainment $200; other personal $150; RRSP $80. Total: $2,055.
Liabilities Mortgage $132,000, George's share $66,000; student loan $21,000; car loan $19,130; credit card $1,000. Total: $107,130
Special to The Globe and Mail
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