Thanks to Goldengirl Finance for this article.La mode, for Joie photocredit
I recently began volunteering with an organization called Girls Inc., one of whose valuable programs that teaches teen girls the basics of investing and money management. By the end of the program, the girls will be competently managing a full-blown investment portfolio. Sadly, that’s something that most adults are unable to do. Most novice investors who come to me for advice have usually been burned badly by trying to trade penny stocks in an online brokerage account – something my teen protégés would never do. Here’s why...
Don’t start with a marathonEven before you start researching stocks as potential investments, you have to start with the basics. First, remember that there is no free lunch. If you are serious about investing, then you will need to start from ground zero and build from there.
- First rule: Apply money basics
- Second rule: Make it grow
- Third rule: Start early
At the end of 35 years, you would have accumulated $728,226…but you’ve paid an eye-popping $271,774 to the Canada Revenue Agency along the way. This is because the growth on your investments is taxed annually at your marginal tax rate (in this case, using a 31.15% tax rate), leaving you an after-tax rate of return of 6.4%. The CRA has collected $270,000 from you for absolutely no reason! That’s why Rule Number Four is so important.
- Fourth rule: Cut taxes
To see what I mean, take the same example I used in Rule Number Three above, except apply it to a Tax-Free Savings Account (TFSA). This is a federal government registered account that lets investments within the account grow completely tax-free. In addition, there is no tax when you withdraw funds from the account. Using the same investment plan described above, when you reach age 65, you will have accumulated $1,067 412 in your TFSA. Yes, read that again - over one million dollars from a $5,000-a-year investment! It’s all yours - and all without paying a cent of tax on that growth…ever.
You get the same type of effect from contributing to a Registered Retirement Savings Plan (RRSP). With an RRSP, your annual contribution limits may be much larger than for a TFSA, based on your earned income. Contributions are also tax deductible, a feature that could earn you a tax refund every year. However, investments grow in the plan on a tax-deferred basis - in other words, you won’t have to pay tax on interest, dividends, or capital gains on investments in an RRSP until you withdraw funds from the plan - at which time withdrawals are treated as ordinary income and taxed at your full marginal rate. Still, there are various maturity options and strategies you can take advantage of to mitigate the tax impact when it comes time to collapse your RRSP.
- Fifth rule: Pay off expensive debt
- Sixth rule: Be flexible