Life is good for Steve and Kathleen. They're both a few years into promising careers and a mortgage on a modest home. But life could always be a little better.
For one thing, the couple in their early 30s would like to upgrade to a larger home to some day start a family.
"We were looking around the $300,000-range," says Kathleen, who earns about $54,000 a year at a post-secondary institution.
Steve, who works in conservation, earns about $42,000 a year.
The couple owns a home worth $220,000, on which they owe $143,000.
Although they're confident they can afford the higher mortgage payments, they worry paying for a larger home will come at the expense of their long-term financial well being.
The couple have amassed a fair amount of savings already. Between them, they have $24,305 in RRSPs -- all in GICs -- and another $21,500 in a LIRA. They also have about $5,500 in a TFSA and about another $18,700 in a non-registered account invested in mutual funds. They have work pensions, but they know very little about them.
In a perfect world, Kathleen says they'd like to retire in their mid-50s, but they're concerned whether they'll have enough money to retire at all.
Steve and Kathleen know financial planning is a balancing act: satisfying the needs of today with those less concrete ones many years down the road. But they need a little bit of help.
"What should we be focusing on doing right now?"
Certified financial planner MaryAnn Kokan-Nyhof says Kathleen and Steve have one thing going for them -- time.
"Thirty years is a long way off for this couple," says the vice-president of a Winnipeg branch of Desjardins Financial Security Investments.
Time allows them to save today and take advantage of compounding annual returns to grow their money.
Yet time can be as much of a hindrance as it is an advantage without careful planning. Kathleen and Steve might get sidetracked. It's easy to spend today, thinking they can just save more later on for retirement. But planning far into the future is always challenging.
It's often difficult to set realistic goals, and not just for the long-term.
Short-term planning is also tricky because immediate goals affect present and future cash flows that in turn have an impact on plans that take decades to be realized. Governments and corporations wrestle with this issue, so it's certainly no small feat for a young couple.
Kokan-Nyhof says upgrading to a bigger home appears to be the priority financially right now, and there's no reason they can't pursue that goal. But caution is the name of the game. They need to know if the numbers really do work for them.
To start, they should pore over their budget. She says the couple appears to have a lot of free cash flow -- or at least money that is unaccounted for in their listed expenses.
"Their net pay cheques add up to $4,766 a month, but all their expenses only amount to $3,456, so where is the other $1,309 going?" she says. "If we assume that they actually are spending only half of that amount, maybe spent on frivolous stuff like lattes, dining out and a few drinks at the bar, then they have about $500 surplus a month that can go toward their goals."
The next step is evaluating their current mortgage situation versus their future one. Kokan-Nyhof says they have about $77,000 worth of equity in their home. After realtor fees and other costs, they should still have enough for a 20 per cent down payment, which means they wouldn't need CMHC financing. Kokan-Nyhof says they could probably even afford a 25 per cent down payment on a home worth about $308,000. "Now, that leaves them with a mortgage of $231,000, which will increase their payments to $600 bi-weekly -- at about three per cent interest -- and they will have it paid off in 20 years," she says.
"That's about $1,300 a month versus the current $956 a month that they are paying."
Even with the higher payment, they should be able to afford to upgrade to a bigger home today -- if they actually do have an extra $500 a month in their budget.
"But they need to go back to the drawing board and re-examine their monthly expenses to see where the waste is first."
This could take a couple of months of carefully tracking expenses and adjusting spending so they not only ensure they have the surplus, but they would also look for additional savings, which they will likely need.
On paper the can afford a bigger home, but they will need breathing room in their budget for emergencies, and they will still have to save for retirement. As a retirement savings goal, Kokan-Nyhof says they should aim to save 10 per cent of their gross income a year.
"For her, that's $5,000 and for him, that's $4,000, however, even if they save that amount, they will not have enough to cover 50 per cent of their current lifestyle costs in retirement if they stick to investing in mostly GICs," Kokan-Nyhof says.
"They have to achieve at least four per cent annual return in their long-term savings to last them until age 85, but if they stay with GICs, they will run out of money at age 72."
Although GICs are stable -- they can't lose money -- these investments barely keep pace with inflation. For instance, if Kathleen and Steve earn two per cent on a five-year GIC and inflation over that period is one per cent, they're only earning one per cent after the effects of inflation.
"This means they require much more money for retirement to keep their lifestyles equal to what they are now."
The X factor is their work pensions. Kathleen and Steve need to meet with their respective human resources contacts at work to learn more about their pension plans because those savings programs, combined their own savings, may add up to 10 per cent or more of their annual gross incomes going toward retirement.
Still, they should consider investing their RRSPs in alternatives to GICs to generate a higher return on their money. Given their situation, their best option is mutual funds, which they already own, so they're not in unfamiliar territory. Mutual funds do involve more market risk than GICs, but over the long-term, they are likely to out-perform GIC returns which means come retirement, Steve and Kathleen should have more money in their pocket.
But they need professional advice, as well as doing a little homework on their own, to find good funds that will suit their goals and appetite for risk.
So while they can at first glance afford to upgrade, it's wise they take their time. After all, that's one thing that Steve and Kathleen have lots of -- so long as they spend it wisely weighing their options to their best advantage.
"They need to prioritize their goals and decide how quickly they want the house against putting money away for the long-term."