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Budgeting 101

Why should I make a budget?

Budgeting forces you to face your finances head-on and understand your spending habits. It can help you:

  • Pinpoint potential problem areas.
  • Prevent overspending.
  • Work towards reaching your financial goals.

How do I make a budget?

Making an effective budget can be as easy as downloading an app on your phone or creating a spreadsheet with two columns: one to track your income and one to track your spending. But if you still don’t know where to start, you can make a simple monthly budget by following these steps:

  1. Calculate your monthly income (all sources of income, after tax).
  2. Calculate your monthly expenditures (all typical expenses and bills).
  3. Compare the two and see how much you have leftover each month.
  4. If possible, dedicate a percentage of that leftover income to paying off any outstanding debts.
  5. If possible, dedicate a percentage of that leftover income to your savings.
  6. Pick some savings goals – like a trip or a car or new shoes or the down payment on a house – and keep working towards it!
  7. Monitor your budget monthly and regularly make adjustments. Remember, it’s okay to be realistic with your numbers.

Things to keep in mind when making a budget

  • Most banking apps now have the capability to track your spending by category (food, travel, entertainment, etc.). You may even be able to download a report so you can view your purchases line-by-line.
  • If you don’t have a regular income, or your expenses vary month-to-month, look at the past six to 12 months of income and spending and use average numbers.
  • If you don’t have enough leftover income to cover your expenses, or barely have enough, it’s time to re-evaluate your spending habits and find areas where you can cut back. Alternatively, you may want to find ways to boost your monthly income.

What if I realize I’m off budget one month?

It’s normal to be off budget by a little! That’s why it’s important to be conscious of your spending, be realistic with your numbers, and make adjustments accordingly. But if you realize you were off budget by a lot, take a look at your numbers and ask yourself the following:

  • Which categories did I overspend? Where can I cut back?
  • Did I overspend because of a one-off situation or is this likely to happen again next month?

How much should I spend and save per month?

Once you’ve reviewed your monthly income versus expenses, you’ll likely be left with a number of excess dollars. But how comfortable are you with that number? Do you know how much you should spend versus how much you should tuck away in a savings account each month?

At the end of the day, everyone has their own unique financial situation, and there is no one-size-fits-all financial plan.

However, a popular method of savings is the “50-30-20" rule.

This rule prompts you to divide your after-tax income between your needs (50 per cent), wants (30 per cent), and savings/debt repayment (20 per cent).

For example, let’s say you’ve calculated that your average monthly income is $3,200 – after tax and including any tips and bonuses. According to the 50-30-20 rule, this means you should dedicate $1,600 to needs, $1,280 to wants, and $640 to debt repayment/savings.

This, of course, means you need to differentiate your “need” expenses and your “want” expenses. Needs include things like your groceries, car payment, housing, utilities, insurance, etc. Wants, on the other hand, are things you can forego and still maintain a decent quality of life, such as new clothes, a gym membership, or that daily morning latte from the café down the street.

When it comes to debt, anything more than the minimum-required payment (whether it be on your credit card, student loan or mortgage) is considered a need since it must be paid. So, for example, if your car payment is $125/month, that expense is considered a need. If you decide to repay more that month, that additional payment is put into the debt repayment category.

And while debt repayment should be a priority, you may also want to put a bit aside in a savings account for retirement, your children’s education, or a new pair of designer shoes – whatever fits your lifestyle.

And once you have a goal in mind, you can easily use the RateSupermarket.ca savings calculator to map out how long it will take for you to get there!

Which banking products should I use to save?

This all depends on your priorities and financial goals.

If you’re saving for retirement, consider contributing to a Registered Retirement Savings Plan (RRSP). Or if you plan on buying your first home in a few years, note that you can also withdraw up to $25,000 from your RRSP through the Home Buyers’ Plan (HBP) for your down payment.

If you’re saving for your children’s education, you may want to open a Registered Education Savings Plan (RESP).

Or if you have other goals, whether they’re short-term or long-term, you may want to look into other types of investments. Some options include:

  • At your bank: Everyone has a chequing or savings account, so you could easily park your money there with no worries, but the problem is, these bank accounts offer little-to-nothing when it comes to interest.
  • High-interest savings account: This is arguably one of the best places to save. High-interest savings accounts are usually only available from online banks. And since they typically have lower carrying costs in comparison to the Big Five banks, they can offer you a much higher interest rate. Some people are hesitant to use an online bank, but if you become a member of the Canadian Deposit Insurance Corporation (CDIC), you can fully insure your money up to $100,000.
  • Guaranteed Investment Certificate (GIC): GICs are some of the safest investments available. They offer a guaranteed return in a fixed amount of time but since this is literally a no-risk investment, the return is quite low. If you need access to your money earlier, you will likely pay a hefty penalty.
  • Investment account: If you’re willing to accept the risks, maybe investing your money is worth your while. This is especially a good strategy for people who aren’t on a set time frame or have a fair amount saved up already, since there may be times of uncertainty in the market.
  • Tax-Free Savings Account (TFSA): Despite its name, your TFSA is not actually a savings account. It’s more of a savings vehicle where you can hold different assets or accounts. TFSAs are best suited for long-term investments.

Investing 101

What is an investment?

An investment is allocated money put into something with the expectation that you’ll receive some kind of return or benefit in the future because of it. Investments can come in many different forms, from accounts to property to businesses. As a monetary asset, an investment could also be sold later on at a higher price for a profit.

Common investment terms

Return: The profit that you make on an investment, also known as “return on investment” (ROI). A return on an investment can be referred to as:

  • Income: This can come in the form of interest or dividends. When a company makes a profit, it pays dividends to its shareholders.
  • Capital gain: When your investment increases in value, and you can sell it for a profit.
  • Capital loss: When your investment decreases in value, and you have a negative return.

Risk tolerance: Your level of comfort with the risk of your investment. If you have a high-risk tolerance, then you are comfortable with the possibility of your investment suddenly increasing and decreasing in value. In contrast, if you have a low-risk tolerance, then you are “risk averse”.

Liquidity: If an asset or investment is liquid, this means you can cash it in or sell it quickly. Savings accounts and most stocks are liquid, whereas a property investment isn’t. Liquidity is important to consider if you’re looking into a short-term investment.

Portfolio: A group of financial assets and different investments managed by a finance professional, like stocks and bonds, mutual funds, securities and even cash.

Portfolio diversification: Having a mix of different investments to reduce risk. Think about it in the sense of not putting all your eggs in one basket. For example, if you invest in multiple companies instead of just one, you lessen the risk of losing all of your money at the same time, even if one company happens to lose value.

What are some different types of investments?

Annuity : This is a type of life insurance investment that’s generally used to generate retirement income. The idea is that you deposit a lump-sum of money that gains interest until you’ve retired. Then, you’re contractually paid you out at regular intervals for a set period of time, or even for the rest of your life.

Bond : A bond is like a loan that you give to an issuer (usually a company or the government). The issuer then agrees to repay the loan with interest at a set rate by a set date.

Canada Savings Bond (CSB): These types of bonds are issued by the federal government. They come with a minimum guaranteed interest rate for a three-year term. They can be cashed in at any time and earn interest up to the day that they are cashed. Canada Savings Bonds are only available through the Payroll Savings Program, which allows Canadians to purchase bonds through payroll deductions.

Exchange Traded Fund (ETF): An ETF is like a basket-full of assets such as stocks, commodities and bonds and is tradable as a package deal on the stock exchange as a common stock.

Guaranteed Investment Certificate (GIC): GICs are some of the safest investments available because they offer a guaranteed return. You can opt for a fixed- or variable-rate GIC, but since this is a no-risk investment, the return is quite low. If you need access to your money before the end of your contractual term, you will likely pay a high fee.

Mutual Fund : Mutual funds are a type of group investment in which many investors pool different securities together – such as stocks, bonds, options, or other securities – to create a portfolio.

Security : Investment securities are essentially tradable investments, such as stocks, bonds and mutual funds.

Segregated Fund : Similar to a mutual fund, this is a type of group investment comprised of different types of securities from different investors to create an overall portfolio. The only difference is that a segregated fund guarantees you that a minimum percentage of the investor’s payments into the fund will be returned once the fund matures.

Stock : These types of investments are also called “shares” or “equities”. It is a unit of ownership in a company that is available for purchase on the stock market. If you have stock in a company, this means that you own a percentage of the company and are entitled to a portion of the company’s earnings and assets. The level of risk in this type of investment depends on the market environment.

Treasury Bill (T-Bill): A T-bill is a type of investment issued by the federal or provincial government. These types of investments are usually short-term and low-risk with fixed terms only up to a year. They are sold in amounts ranging from $1,000 to $1 million.

What does it mean to have a low-risk or high-risk investment?

Investments are typically described by level of risk, based on how likely or unlikely you are to get a return. When you have a low- or no-risk investment, a return is often guaranteed. Types of low-risk investments include your typical savings accounts, GICs, and treasury bills.

When you have a high-risk investment, your financial advisor may be able to make predictions based on market performance, but your return is usually not guaranteed. Types of high-risk investments include stock market shares, mutual funds, and ETFs (though this also depends on the type of funds in the ETF). People often opt for moderate- or high-risk investments in hopes of a larger return, whereas low-risk investments are safe, and usually don’t have a high rate-of-return.

How much does it cost to buy or sell an investment?

Not all investments come with a cost. But depending on the type of investment, there may be associated costs and fees to buy or sell one. It’s important to understand these costs before committing to an investment, so there are no surprises when you get your return.

When you buy an investment, types of fees you may face include:

  • Financial advisor fees.
  • Administration fees on registered plans.
  • Sales commissions when you buy bonds (though these are usually included in the purchase price).
  • Trading fees when you purchase a stock or ETF (though these are dependent on the brokerage or investment firms you use).
  • Front-end load fees: An upfront fee sometimes required to buy a mutual fund – usually a percentage of the fund’s purchase price. In contrast, “no load” mutual funds don’t come with an upfront fee.

On the other hand, if you plan on selling a mutual fund, you may be required to pay a back-end load fee: Some mutual funds will actually come with a back-end load fee to be paid when you sell the fund, rather than a front-end load fee to be paid when you buy it. The back-end load fee is typically a percentage of your selling price. And while they start off high in the first year after purchase (sometimes as high as seven per cent), they gradually decrease the longer that you hold on to the investment. If you hold on to the investment long enough, you may even be able to negotiate waiving the fee altogether with your fund dealer.

What is a MER?

Some investment funds, including mutual funds, charge a fee called the “management expense ratio” (MER) to manage the fund. The MER is calculated as a percentage of the fund’s value, and it includes commission for the financial advisors who sell the fund. And depending on the fund, this percentage can vary.

This fee is deducted before the return is calculated, and is paid out whether you get a return on the fund or not. For example, if your investment has an annual return of five per cent, but your fund’s MER is two per cent, your return would only be three per cent.

How do I start investing?

It may seem complex, but you don’t need to be a stock broker to start your investment journey.In fact, if you have a regular savings account issued from your bank, you’re already investing – even if it makes a small return.

The best way to approach investing is to start small and understand your financial priorities before committing to a fund.

Some questions you can start asking yourself:

  • How much money are you willing to invest?
  • How long do you want to keep your money in an investment? Are you looking for a short-term or long-term commitment? Do you plan on buying a car and need access to your money within a few months? Or are you okay with putting away that money for five years?

When considering risk level, you should also ask yourself a few other questions, like:

  • Could you tolerate an unpredictable investment that suddenly changes in value?
  • Do you have a stable job?
  • Do you enough saved in case of an emergency or to cover debts?

You may want to get your feet wet by opening a tax-free savings account (TFSA) or a GIC. Or maybe you want to start saving for retirement and are looking at contributing to your work’s group RRSP. Or you may want to talk to a financial advisor at your bank who can guide you in choosing a higher-risk mutual fund and creating a portfolio.

As always, do your research, shop around and compare options to make sure the investment you choose is competitive and fits your lifestyle. You can easily find the best TFSAs, RRSPs, savings accounts or fixed- and variable-rates GICs at RateSupermarket.ca.

Credit Score 101

What is a credit score?

A credit score is a number used to measure your level of creditworthiness and overall financial responsibility. It’s a three digit number that usually ranges from 300 to 900, and is calculated based on a few factors, including how much debt you have, how long you’ve had debt, and your history of repaying debt, from credit card debt to your mortgage.

What is a credit report?

Your credit report is a detailed record of your credit history, that typically includes:

  • Your name
  • Your address
  • Employer name and address
  • Outstanding and closed loans
  • Lines of credit
  • Credit card balances and maximums
  • Loan payment records
  • Inquiries from other companies for your credit score/report

This information is collected by the national credit reporting agencies – Equifax and TransUnion. Your credit score is calculated using information from your credit report, and lenders usually request your report from a bureau when you apply for credit.

Each one of these bureaus has their own scoring algorithm, and sometimes lenders will only report to one bureau and not the other. Thus, there may be variances in your score and report between the two bureaus, and this is completely normal.

How is my credit score calculated?

Your credit score is impacted by a few factors:

  • Your credit utilization ratio: This is the amount of credit you use versus the total amount of credit available to you. Generally, creditors don’t like when you use more than 20 to 30 per cent of your total available credit, because it indicates that you may be experiencing financial difficulties. Thus, your score may take a hit if you use more.
  • Your personal credit history: Credit bureaus take all your credit accounts into consideration, including credit cards, lines of credit, retail department store accounts, installment loans, auto loans, student loans, finance company accounts, home equity loans, and mortgage loans. They look at things like how many accounts you have open, the type of credit, and how long you’ve had these accounts open. Usually, you get points when you’ve had an account open for a long time, because this shows creditors that you’ve been able to maintain the account and keep it in good standing by paying your debts on time. Your personal credit history bears a lot of weight on your credit score.
  • Your payment history: Creditors like when you repay your debts on time. But your credit score can be affected negatively if you have late or missed payments. How late the payments were, how much was owed, and how often you’ve missed payments are taken into account, as well as public record items and collection information.
  • Public records: If you have a history of bankruptcies, consumer proposals, legal judgements, or debt sent to collections, this will negatively impact your credit score because you are considered to be a risk to lenders.
  • Inquiries into your credit report: Anytime you apply for credit and a lender requests access to your credit file, this is logged on file as a “hard” inquiry. This can affect your score if you apply for multiple accounts around the same time, because it may indicate that you’re in financial trouble. It should be noted, though, that inquiries into your report for pre-approval on credit are not considered hard inquiries and won’t affect your score. Same thing goes for when you check your score yourself. These are considered “soft inquiries.”

How is my credit score used?

Lenders usually look at your credit score when you apply for new credit such as auto loans, personal loans, mortgages, home equity loans, credit cards and retail card accounts. That way, they can determine if you are financially responsibly, decide on whether to approve your loan application, and offer you an appropriate interest rate. If you have good credit, lenders will likely give you a better, lower rate, because they believe you’ll pay back your debts on time anyway.

However, your credit score/ report may also be requested on other occasions when your creditworthiness is in question, such as when you are:

  • Applying for a lease on a property
  • Applying for a job
  • Applying for car/home insurance
  • Signing up for utility services
  • Signing up for a cell phone plan

How long do things stay on your credit report?

Both Equifax and TransUnion keep positive credit information on file for up to 10 years from the last date a transaction was made on the account.

However, negative information stays on your report for varying lengths of time, depending on the credit bureau and the terms of the infraction.

For example, inquiries may remain on your credit report for a few years. Equifax keeps negative hard inquiries (for example, from a collection agency) for three years, whereas TransUnion keeps it on record for six years – both from the date the inquiry was made. TransUnion, though, keeps “soft” inquiries on file for two years in Quebec, and one year everywhere else.

More serious infractions like legal judgements, debt sent to collections, registered items, consumer proposals and bankruptcies may stay on your report anywhere upwards of five years.

Where can I find my credit score/report? Do I need to pay for it?

You can find your credit score online from sites like CreditKarma.ca and Borrowell.com for free. If you need a full credit report, you have to order it through Equifax or TransUnion. You are entitled to one free report per year, but you can pay to obtain additional ones.

Can I check my credit score without affecting it?

Checking your own credit score using an online credit checking service like CreditKarma.ca and Borrowell.com will not affect your credit score. If you check your own credit score, it's considered a soft hit. Generally, your credit score is only negatively affected by hard inquiries into your record.

What is secured and unsecured credit?

The main difference is that secured credit requires you to put up some form of collateral for approval. This is why it is easier to get approval for secured credit.

For example, a mortgage is considered a secured loan. If you are unable to make your mortgage payments, your home can be taken away as collateral, in what’s known as foreclosure.

Secured loans are also given at lower interest rates. They are definitely a viable option for those who have a hard time getting a loan due to their poor credit rating, since your score doesn’t bear as much weight in the approval process.

On the other hand, unsecured loans do not require collateral. But as a result, these types of loans usually come at lower amounts with higher interest rates since the lender is taking on more risk.

For example, credit card accounts are considered a type of unsecured loan. When you apply for a credit card, you are not required to put up collateral, and nothing will be taken from you if you fail to pay your balance on time. But you will be charged a great amount of interest if you make a late payment, and if you fail to pay altogether, your file will likely be sent to a debt collection agency.

Since no collateral is involved, your credit score bears a lot of weight on your unsecured credit application. Lenders need to know if you’ll pay your bills on time, so before approving an unsecured loan, they will deeply dive into your credit history and take your current score into consideration.

What is a hard inquiry and a soft inquiry?

When you apply for new credit (credit card, loan, mortgage), your bank sends in a request to the credit bureau (either Equifax or TransUnion) for your current credit score. This is known as a hard inquiry. Too many hard inquiries into your credit report could harm your score, because in the eyes of the credit bureau, applying for new credit is an indication of someone who may be having financial difficulties.

On the other hand, a soft inquiry usually happens when a person or employer conducts a background check on you, or when you check your own credit score. Soft inquiries don’t impact your score and are sometimes not even noted on your credit record.

How do I build credit or improve my credit?

If you are looking to improve your credit score or have no credit history at all, here are some ways to build and maintain good credit:

  • Get a credit card: If you've never had a credit card before, apply for one and use it responsibly. You can begin building your credit history by spending a bit and repaying your balance in full every month. If you have problems getting approval for a regular credit card, consider applying for a secured card – it will still help you build credit.
  • Become an authorized user: If you have no (or poor) credit, but your parent, spouse or sibling has a credit card account in good standing, becoming a secondary user on their account will put you on track to building good credit. One of the biggest factors that influences your credit score is the length of credit history associated with your file.
  • Make your payments on time: Your credit score will be negatively impacted by missed or late payments. Start making payments on time and in full; minimum payments are not your friend.
  • Keep your debt load low: If you have high amounts of debt, make a plan to pay it off as soon as possible. You may also want to negotiate with the lender to set up a more reasonable payment plan to get you out of debt faster.
  • Keep your credit-utilization ratio low: Aim to use only 20 to 30 per cent of your total available credit each month. Credit bureaus assume you’re in financial trouble if you use too much credit, and your credit score will be affected as a result.
  • Ask for more credit: If your score is taking a hit due to a high credit-utilization ratio, ask your lender for a limit increase to boost your available credit, thus, decreasing your ratio.
  • Limit applications for new credit: If you have bad credit due to too many inquiries into your record, stop applying for new credit. As mentioned, credit card lenders do a hard inquiry into your credit report when you apply for new credit since it’s an indication that you are in financial trouble. Therefore, every time you apply for a new credit, your score takes a hit.

Once you have done all you can to adopt responsible financial habits, boost your score, and repay your debt, check your record to see if any past transgressions have been removed. Ensure that the information is accurate and once you’re in the clear, it’s important to apply for new credit and use it responsibly.

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