As Canadians’ debt levels rise, so too do their worries over how to repay these obligations while achieving other financial goals. For financial advisors, addressing the liabilities side of a client’s balance sheet is crucial – and that often requires a deep dive into the reasons behind the debt and a custom strategy to tackle it.
Kim MacDonald, investment advisor with MacDonald Advisory at Raymond James Ltd. in Edmonton, says the debt conversation has been coming up more often with clients because of factors such as divorce, challenges related to the rental real estate market in Alberta and greater borrowing as a result of low interest rates. The latter issue in particular, she says, is often a slippery slope.
“We know that we can have larger debts because it doesn’t cost as much to pay for our monthly or bi-weekly payments, but are we thinking ahead enough to know what we might have to pay if interest rates go up? That’s part of financial planning,” she says.
In the fourth quarter of 2019, the debt-service ratio for Canadian households – or the proportion of disposable income required to meet debt obligations – reached an all-time high of 15 per cent, with more than half going toward interest payments, Statistics Canada reports. And a recent poll from Canadian Imperial Bank of Commerce (CIBC) found that paying off debt was Canadians’ top financial priority for the 10th year in a row.
That situation is likely to become more dire as many Canadians may have to tap into debt to meet their short-term obligations during the COVID-19 pandemic.
With clients concerned about their debt levels, advisors should start by analyzing their liabilities before developing a plan, says Jamie Golombek, managing director, tax and estate planning, at CIBC.
“Once we determine what [the debt is], we determine whether we can put a strategy in place to either pay off that debt or, in some cases, not worry about it,” he says.
For situations involving “good” debt – for example, a mortgage incurred at a relatively low interest rate – clients are often advised to set aside some of their monthly budget to save for retirement in a registered retirement savings plan (RRSP) or tax-free savings account rather than focusing on paying off the debt, he says.
On the other hand, in situations in which clients hold a lot of “bad” debt – such as a home-equity line of credit or a credit card balance with an annual interest rate of about 20 per cent – clients should be advised to prioritize paying these off first, Mr. Golombek says.
In fact, he says advisors need to place a bigger emphasis on liabilities during conversations with clients rather than focusing solely on investments.
“A lot of advisors are focusing on the investments. ... But if you’re a client paying 20 per cent interest on your credit card, I don’t think you should be investing at all,” Mr. Golombek says. “Ultimately, if we can get you out of that situation, we can set aside more money in the monthly budget toward achieving the other real goals.”
Scott Evans, financial advisor at BlueShore Financial in Vancouver, agrees. He says advisors need to spend more time working with clients who are not paying down their high-interest debt and have insufficient plans for retirement.
“They’ve come to a point now at which maybe they’ve been carrying that line of credit for a while without making any savings [for] their retirement and they need some help with prioritizing,” he says. “Advisors can really show their worth and come up with the steps that are going to help them achieve their goals.”
As with all client situations, the process begins with creating a plan, Ms. MacDonald says. In cases that involve substantial debt, tailored solutions often lead to better results than textbook approaches, as the reasons behind that debt can be very different. For example, one client may have liabilities after dividing debts in a divorce, while another may be dealing with a gambling addiction.
Well-known strategies, such as the snowball method – in which individuals start by paying off smaller balances to gain momentum – may work for those who need an early win, she says. Others may only achieve success by making significant lifestyle changes.
In some cases, advisors may need to consider other approaches such as a consolidation loan or line of credit strategy that puts clients on a fixed monthly budget and debt repayment is included as a line item, Mr. Golombek says.
Some may be able to combine saving for retirement with paying down debt by using the refund generated from an RRSP contribution to pay a lump-sum on a line of credit, Mr. Evans says.
As it will ultimately be up to the client to prioritize debt repayment, strategies that work are almost always developed alongside clients, Ms. MacDonald says.
That allows individuals to visualize the impact of the different scenarios; stress test debt in higher interest interest-rate environments; provide a wake-up call to make behavioural changes, if necessary; and come up with solutions that work for their lifestyle.
“Working through these debt strategies using comprehensive planning software with the client is where we’re seeing results,” Ms. MacDonald says. “If they understand why they’re doing what they’re doing, then they almost feel a sense of relief.”