Mistakes happen frequently. There was that time when Coca-Cola launched New Coke, when AOL merged with Time Warner, and when Microsoft introduced the Zune.
While you might not make such bad errors in judgment, you can make terrible mistakes with your money. Here are three of the most frequent ones:
1. Not knowing where your money’s going
While you likely know exactly what your mortgage or rent payment is, you probably don’t know how much you spend on dining out, gas, entertainment, or other variable needs and wants.
That’s why you need to have a budget and allocate money towards certain expenses every month. Be sure to keep track of your spending in a spreadsheet or an app in order to see how you’re spending your money. After a month or two, you might be surprised. If that’s the case, you can begin making adjustments and cut back on some expenses.
You should also set aside a certain amount of money every month to build an emergency fund and save for retirement. The easiest way to do this is to create an automatic savings plan. Forcing yourself to save means you have to live on a smaller amount and you won’t be able to spend money you don’t have.
2. Incorrect use of/not using a TFSA or an RRSP
There are two major accounts investors can use to experience tax-sheltered growth. There’s the relatively new kid on the block, the TFSA, and the old standby, the RRSP. But many people aren’t using either account properly or not using either account at all. According to Statistics Canada, only 22.9% of tax filers contributed to an RRSP in 2015 (the latest number available).
Some common mistakes related to RRSPs and TFSAs include:
Not making a contribution (RRSPs and TFSAs)—RRSPs are designed for saving for retirement while TFSAs can be used to save for retirement or other financial goals. If you have high-interest debt, it makes sense not to make a contribution to either account. But if you have money sitting around, you should be saving it in either an RRSP or a TFSA.
Making an over-contribution(RRSPs and TFSAs)—The RRSP contribution limit for the 2017 tax year is the lesser of 18% of your previous year’s earned income or $26,010, plus any unused room from previous years. Although you’re allowed a lifetime over-contribution limit of $2,000, you’ll have to pay a penalty of 1% every month on the amount you over-contribute. For TFSAs, the contribution limit is $5,500 in 2017, plus any unused TFSA contribution room from previous years. The 1% monthly penalty on the amount you over-contribute also applies to TFSAs. To avoid paying a penalty, find out how much room you have before making a contribution to either account. Your notice of assessment will tell you how much RRSP contribution room you have. To check how much your TFSA contribution room you have, contact the Canada Revenue Agency.
Waiting to make a contribution (RRSPs)—If you’re one of those people who wait to make an RRSP contribution until the last minute, you’re not alone. A 2015 CIBC survey found that half of Canadians intending to make an RRSP contribution were leaving it to the final two weeks before the deadline. Your money has more time to compound if you make contributions on a regular basis, leaving you with more money at retirement. Even though the RRSP contribution deadline for the 2017 tax year is March 1, 2018, you can start putting money into your account now.
Holding cash (RRSPs and TFSAs)—When people make a last-minute RRSP contribution, they usually hold cash or buy a money-market fund because they haven’t had the time to make an investment decision. And even though a TFSA is a tax-free savings account, it should be treated as a tax-free investment account since you can hold GICs, stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Holding riskier investments and being able to shelter any investment income make RRSPs and TFSAs so attractive. If you hold cash and you’re only earning 1% or 2% in interest, the tax savings will be minimal.
Making an early withdrawal (RRSPs)—If you’re thinking about withdrawing money from your RRSP to pay down debt, buy a car, or to take a vacation, think again. When you make an early RRSP withdrawal, you have to pay tax on the amount you withdraw. You also don’t regain the RRSP contribution room if you make a withdrawal and your money has less time to compound. However, if you take advantage of the Home Buyers’ Plan or the Lifelong Learning Plan, your money isn’t taxed unless you don’t repay the amount you withdraw.
3. Paying high fees on financial products
If you’re one of those people with a chequing account that comes with a $30 monthly fee, you’re paying too much. You can get most of the same services and features with an online chequing account offered by PC Financial or Tangerine. Best of all, there’s no monthly fee.
Mutual funds are also known for having high costs. If you have an investment advisor, there are times where you may have to pay a commission (called a load or a sales charge) when you buy or sell the funds. You also have to pay an annual fee—the management expense ratio (MER)—which can eat into your investment returns. According to a 2015 Morningstar report, the average MER for Canadian equity funds was 2.35% or 2.35 cents in fees for each dollar you invest.
Instead, you can buy index funds—which are passively managed—from a number of financial institutions that charge lower MERs. For example, the TD e-Series funds have MERs as low as 0.33%. That equals 0.33 cents in fees for every dollar you invest. Or you can buy ETFs, which usually have lower MERs than index funds. If you’re not a fan of indexing and want your money managed by a professional, Mawer Investment Management, Steadyhand, Leith Wheeler, and PH&N all offer lower-cost funds than some of the larger mutual fund companies and banks.