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Cheat Sheet

Building Wealth All-in-One For Canadians For Dummies

Many Canadians assume that the only way to build wealth is to score some high stock market returns. But if anything's apparent since the 2008 financial crisis, it’s that markets alone won’t get you rich. After seeing your portfolio fall during the recession, you may be wondering how one can possibly build wealth in an unpredictable economic environment — but you can. Many people still retire wealthy every day. This Cheat Sheet provides a helpful overview of some of the basic steps to building wealth.

Quick Tips for Tracking Your Net Worth

Tracking your net worth over a period of time can help you keep a cool head as you work toward building your wealth. By looking at the big picture, you don’t get as discouraged when an investment stumbles, as long as other investments are still gaining in value. Knowing that hitting a bump in the road doesn’t mean you’ll fall short of your destination can help get you back on track to meet your long-term financial goals.

How does this work? Don’t simply complete one net worth statement and call it a day. Here’s how to look at your net worth:

  1. Commit to calculating your net worth periodically.

    This can be quarterly, semiannually, or annually. More frequently than quarterly is overkill; less frequently than annually may put you way off course when you do review your position.

  2. Calculate your initial net worth.

    The difference between your assets and your liabilities is your net worth, which is what gives you stability in times of financial uncertainty. Your net worth statement summarizes what you own, what you owe, and what would be left if you paid off all debt. Assets include money, investments, the fair market value of your house and furniture, your car, other real estate, and anything else you own.

    Liabilities include mortgages, car loans, credit card debt, and any other amounts owing like taxes. Here’s how to determine your net worth:

    Net worth = Assets – Liabilities

  3. Re-calculate your net worth at the next calculation period.

    Tracking your net worth periodically through the ups and downs in the economic cycle can prevent you from losing sight of your financial progress.

  4. Compare the changes in assets, liabilities, and overall net worth.

    Are you getting closer to your goals or farther away from them? Make a point of understanding the general direction of each category. Are your assets lower now because your investments are down with the market? Or are your investments down while the market is up? Are you spending more than you’re earning and depleting your assets to cover your living expenses?

  5. Identify where you have control over improving your financial direction.

    Find out whether you’re increasing your assets through saving or decreasing your assets through spending or whether your invested assets are growing at the rate you expect, as well as how you’re doing in your quest to eliminate your debt and taxes.

  6. Plan actions to increase your net worth before the next review period.

    Think of your lifetime income and earnings as a pipeline that flows from when you start making money to the last day of your life. Along the way, various faucets in the pipeline open and divert money to pay for needs (such as living expenses, a home purchase, taxes, education, furniture, and transportation) and wants (like big-screen TVs, vacations, a fishing boat, and more).

    For items you buy using debt — mortgages, loans, credit card purchases — the faucet opens wider and runs longer because you’re paying not only for the item but also for interest. The result is that you have to either work longer to earn more money to repay the debt or scale back on your goals.

How to Avoid Bad Debt

The first step to building wealth is to avoid unnecessary debt. Not only does setting aside money for future expenses save you the cost of debt interest payments, but it can also earn money for you if you invest your saved cash in an interest-bearing account. As you save, you help fill your pipeline instead of draining it!

Four criteria determine whether debt is good or bad. Before taking on debt, ask yourself the following questions. If the answer to all four questions is yes, you’re signing up for good debt:

  • Is it a need? If dependable transportation is a requirement for your job, buying a car to replace one that’s on its last legs is clearly a need. But if your TV works and those ads for big-screen flat-panel models are making your mouth water, that’s a want — which leads to bad debt.

  • Do you need to buy it before you can save up for it? Consider the timing. You’re looking at good debt if your car is beyond repair and you need dependable transportation to keep your job. If the big-screen TV is on sale this weekend, you can wait. It’ll almost certainly be cheaper six months down the line.

  • Can you afford the payment? If the payment fits your budget, you won’t have to cut back on other needs. That’s good debt. If you can’t afford it, you’ll have to cut back on some newly defined extras — like gas, food, and braces for the kids.

  • Are the financing terms okay? Check the rate, terms, and prepayment penalties.

With good debt, you may have checked with your bank, credit union, or trust company, so you know the interest rate is competitive and the length of the car loan isn’t longer than 48 months.

You’re into bad debt if you use the in-store financing to buy that new couch. The danger: If you don’t pay off your purchase within the allotted time, the finance company generally applies interest retroactively, effective from the date of purchase at rates as high as 35 percent! So that $1,000 sofa could suddenly cost you at least $1,350, and interest continues to accumulate until you pay it off.

Saving up for a future expenditure keeps you in control of your money. By signing up for debt, you give away that control. Avoiding bad debt keeps more money in your income pipeline going toward your needs, wants, and other goals.

What Is a Tax-Free Savings Account in Canada?

Canada Revenue Agency (CRA) has added to the average Canadian’s bag of retirement planning tools by offering up the new Tax-Free Savings Account (TFSA). As of January 2009, you can shelter up to $5,000 a year in investments in a TFSA. Although you won’t get a tax deduction for the money you invest, as you would with an RRSP, you can withdraw money from your TFSA tax-free at any time and then replace it the following year.

Like all government-implemented tax shelters, TFSAs have rules. Keep in mind the following points:

  • You can begin to contribute to a TFSA at 18 — all you need is a Social Insurance Number (SIN).

  • TFSA contribution room accumulates even if you don’t open an account.

  • Overcontributions are subject to a penalty tax of 1 percent per month.

  • Eligible investments in a TFSA run the gamut from daily interest savings accounts to stocks, mutual funds, bonds, GICs, and, in some cases, shares in small business corporations.

  • Income earned in a TFSA, including interest, dividends, or capital gains, isn’t taxable.

  • Unlike any other tax-advantaged savings vehicle, you will recover contribution room the year after you make a withdrawal.

  • If you die, the fair market value of your TFSA goes into your estate tax-free but any gain or income that builds up afterward is taxable.

You can make contributions for your spouse to a TFSA, as well as for an adult child or other relative, even a friend, so that they too can reach their own annual contribution limit. You won’t get a tax deduction for your contribution, but the income earned on the money won’t be attributed back to you.

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