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financial facelift

(Justin Tang for The Globe and Mail) FaceliftJustin Tang/The Globe and Mail

With a good job and more than $115,000 in savings, David had been looking to buy a house in the Ontario city where he lives. He’s 27, single and earning $93,000 a year plus bonus. He recently took the plunge, putting in a successful offer for a bungalow that has the potential for a basement apartment. He put 20-per-cent down, leaving him with a mortgage of $395,000 and virtually no ready cash.

David hopes to get married and have children some day, but in the meantime he is trying to get himself on a solid financial footing for the long term. Given the economic uncertainty flowing from the COVID pandemic, he is concerned, too, about job security, although he believes he could find other work in his field without too much trouble.

“What do I need in place to be prepared for job insecurity while carrying a mortgage payment?” David asks in an e-mail. “What steps can I take today to put myself in a strong position for future needs – marriage, children, retirement – and how do I estimate those target amounts today?” Short term, he’d like to travel more. Long term, he’d like to retire by the age of 60 – but that’s a long way off.

We asked Stephanie Douglas, partner, portfolio manager and financial planner at Harris Douglas Asset Management in Toronto, to look at David’s situation.

What the expert says

David has liquidated most of his assets, including his registered retirement savings plan (through the federal Home Buyers' Plan) for the down payment on the house, Ms. Douglas says. He plans to spend $10,000 next year renovating the basement so he can rent it out and generate income to help cover some of his mortgage costs. He hopes to have the renovations finished by next spring and rent the unit for $1,000 a month.

After the purchase of the house closes, David will be left with only $2,000 in accessible cash for emergencies and home expenses, the planner says. While he acknowledges that his parents could help him in an emergency, he would rather not ask them.

David’s move is not without risks, the planner says. “I cannot stress enough the importance of having adequate funds available for emergencies before making the leap into home ownership,” she says. “This is the biggest red flag that I see with David’s plan. There are so many things that can go wrong when you own a house,” she adds. “Unfortunately, you do not always have time to plan for these things.” Not having an emergency fund can cause things to spiral out of control, Ms. Douglas says.

Having an emergency fund would not only help David with unexpected repairs on his house, but it would also to help insulate him from job loss. His emergency fund should be sufficient to protect against loss of income from his job and his future rental unit for three to six months, she says. Depending on his spending requirements, this would be anywhere from $11,000 to $22,000. His monthly expenses would be $3,650 (assuming he has to pay the entire mortgage and has no tenant). While he could save a bit more to cover emergencies related to the house, he would also be qualifying for EI and has severance (six weeks of pay and four weeks of banked vacation pay). Ms. Douglas also suggests that David apply for a line of credit with his bank for emergencies. “It is better to apply for one while he is employed even if he never uses it.”

Based on his predicted spending, David will have an annual surplus of roughly $19,000 once the basement suite is rented out. While he has budgeted for a cut to his discretionary expenses once he takes possession of the property, he should monitor his expenses closely. “This will be particularly important post COVID-19 as his spending will likely creep up then.” If he feels constricted by his budget, David does have the option of renting out the main floor and living in the basement.

David needs to balance his short-term goal of travelling with his longer-term goals, the planner says. Once he has saved enough money for his emergency fund, he should direct any surplus income to maximize his RRSP every year and then to his tax-free savings account. Funds required for his short-term goals (less than five years) should be kept in cash or guaranteed investment certificates so they are readily accessible.

David has a deferred profit-sharing plan through his employer to which he contributes 6 per cent of his income to a group RRSP and his employer matches up to 3 per cent. “He has been taking advantage of this and he should continue to do so because it is essentially free money,” Ms. Douglas says.

His employer also offers an employee share purchase plan in which shares of the company can be purchased at a 15-per-cent discount up to a limit of 10 per cent of his salary and bonus. He should also take advantage of this plan, keeping an eye on how this will affect his portfolio in the long-term. “While his company’s shares have done well, at some point a significant portion of his net worth would be invested in one company, so he should monitor this,” the planner says. “While it is a wonderful perk to have, if he keeps the shares, he will start to have more and more risk associated with one company.” David could sell some of the shares over time and buy others to keep his portfolio properly diversified.

He should also consider moving any shares that he decides to keep over to his tax-free savings account or RRSP account to benefit from the long-term, tax-free growth (or tax-deferred growth in the case of an RRSP), the planner says. This will have tax implications. “If you transfer securities that have a capital loss from a non-registered account to an RRSP or TFSA, the Canada Revenue Agency will deny the capital loss so you will not be able to use this to offset capital gains. A capital gain, however, would be taxable.”

While it is far too soon to predict how well off David will be 30 or more years from now, the planner offers a hypothetical forecast to illustrate the importance of saving and investing over the very long term.

“If David is able to keep his savings rate the same over time, maxing out his RRSP contribution room, with the majority of that coming from the contributions made to his group RRSP, with his company continuing to contribute to his DPSP, and David contributing to his company’s share purchase plan (with adjustments made for inflation as his salary increases), and based on a rate of return of 5 per cent, he would have a net worth of about $3-million at age 60, with roughly $960,000 of that coming from his property,” Ms. Douglas says.


Client situation

The person: David, age 27

The problem: What can he do to put himself in a strong financial position for the future?

The plan: Focus on building an emergency fund and then saving more for his short- and long-term goals. Review plan regularly.

The payoff: Some comfort that he knows what to do to weather unexpected events such as house repair or even job loss.

Monthly net income: $6,450 (includes future rental income)

Assets: House $511,000, savings $2,000, deferred profit-sharing plan $7,000. Total: $520,000

Monthly distributions (year ahead): Mortgage, property insurance, utilities and repairs $1,980; property tax $380; transportation, gas, car insurance, maintenance, parking $480; groceries $200; clothing $85; vacation $50; gifts, charity $75; other discretionary spending $10; entertainment, dining out, alcohol, hobbies, personal care $325; health care expenses $15; internet, cable $50; group RRSP contributions $ 465; employee share purchase plan $775. Total: $4,890

Liabilities: Mortgage $ 395,000

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Some details may be changed to protect the privacy of the persons profiled.

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