I was 19 or 20 years old when I first started investing. I diligently put money aside every paycheque, starting with $50 every two weeks and eventually increasing that to $200 per month.
Sounds like I was off to a great start, right? Wrong!
Related: How Young Investors Can Get Started
Even though my intentions were good, my first attempt at investing for the future was a complete disaster. Here’s why:
It’s good practice to save a portion of your income for the future, even at a young age. The problem for me was that I was still in school and didn’t have a plan – I didn’t really know what I was saving for.
I had read The Wealthy Barber and The Millionaire Next Door and so I knew the earlier I started putting away money for retirement, the longer I’d have compound interest working on my side, and the bigger my nest egg would be.
Related: The Best Time To Start Saving Is Now
Unfortunately I was saving for retirement at the expense of any other short term goals, like paying off my student loans, buying a used car or saving for a down payment on a house.
I worked part-time while I was going to school, but the hours were irregular. I never developed a proper budget to make sure that my school expenses, living expenses and partying expenses were under control.
The results were predictable; I spent more than I earned and then resorted to using a credit card to get me through most months. It didn’t take long to build up $5,000 in credit card debt, when all the while I was still putting a couple hundred bucks per month into my RRSP.
No Savings Account
Speaking of RRSPs, what was a 20-year old kid doing opening up an RRSP when he’s making $15,000 per year?
There were no real tax advantages for me to save within an RRSP when I was in such a low tax bracket. I’m sure I blew my tax refunds anyway, so what was the point?
And carrying credit card debt (at 18% interest) alongside of my investments was a bad idea.
No Clue about Fees and Tracking Performance
Like a typical young investor I used mutual funds to build my investment portfolio. I was encouraged to select all-equity growth funds because, I was told, they would deliver the highest returns over the long term.
What the bank advisors don’t tell you is the management expense ratio (MER) on some of these funds are over 2.5% and those fees will have a negative impact on your investment returns.
Bank advisors also don’t tell you what benchmark these funds are tracking (and trying to beat) so when you get your statements in the mail it’s impossible to determine how well your investments are doing compared to the rest of the market.
No Choice but to Sell
My credit cards were maxed out and I was living paycheque to paycheque with no way to break the cycle. I had no choice but to raid my RRSPs to pay off my credit card debt and get my finances back on track.
Taking money out of your RRSP early means you’ll owe taxes up front. Withdrawals up to $5,000 are subject to 10% withholding tax, between $5,000 and $15,000 will cost you 20%, and withdrawals over $15,000 will cost you $30%.
Your financial institution withholds tax on the money you take out and pays it directly to the government. So when I took out $10,000 from my RRSP, the bank withheld $2,000 and I was left with $8,000.
In addition to the withholding tax I also had to report the $8,000 as taxable income that year.
While I can’t really argue with my reasons for selling, my dumb decisions beforehand cost me a lot of money and caused me to start over from scratch.
If I had to do things over again today I would have done the following:
- Create a budget – This is the foundation for responsible money management. Had I used a budget and tracked my expenses properly from an early age I would have lived within my means and kept my spending under control.
- Open a tax free savings account – Yes, the TFSA wasn’t around back then but for today’s youth it makes much more sense to save within your TFSA instead of your RRSP like I did. You can put $5,500 per year inside your TFSA and withdraw the money tax free. You’ll contribute with after-tax dollars, so you won’t get a tax refund, but you’ll likely be in a low tax bracket anyway, so contributing to an RRSP won’t give you much of a refund either.
- Make a financial plan – We all have financial goals and even at a young age I should have identified some short-and-long term priorities to save toward. I’d take a three-pronged approach where I used a high interest savings account to fund my short term goals, my TFSA to fund mid-to-long term goals, and eventually open an RRSP to save for retirement. No doubt I’d be much further ahead today if I took this approach earlier in life.
- Use index funds or ETFs – Now that I know how destructive fees can be to your portfolio, I’d look into building up my investments using low cost index funds (like TD e-series) or ETFs. The advantage to using index funds is that you can make regular contributions at no cost while achieving the same returns as the market, minus a small management fee (the MER on TD’s Canadian index e-series fund is just 0.33%). Some brokers, like Questrade, also offer free commissions when you purchase ETFs.
Related: 4 Investing Mistakes To Avoid
Did you make similar mistakes when you first started investing? How did you overcome them?