In the first step to save a million dollars, the theme was to research and pursue a suitable career with great earning potentials. For the second step, the central theme will be keeping more of our hard-earned money. In my minimizing your income tax post, I mentioned that “It’s not how much you make. It’s how much you get to keep.” This number is much more important and meaningful to us as savers than the gross amount of income that we make. By knowing approximately how much of our gross income that we get to keep, we can devise a suitable investment strategy to grow our savings and have that amount of money working harder for us. Eventually, our goal is to have our savings do all the hard work and we reap the benefit. Sounds good? Do I still have your attention? Great. Let the saving begin.
Student Loan Debt
In order for us to save money, we will have to have income, which means we need to be in the workforce. So the starting point for most people to save money is right after we complete our education and graduate with a degree of some sort (and hopefully it’s in the field that we are passionate about). From a recent National Post article, the average Canadian student graduated with a whopping $26,819 in student loans in 2015 (my student loan debt was $30,000 when I graduated back in 2003). That’s a deep hole to be digging ourselves out of when we’re just starting a new chapter of our lives. This is the first real obstacle that most of us will be facing early in our saving endevour. To put that into perspective, let’s say that the interest rate on the student loan is 5%, it’ll take the borrow 15 years to pay off the student loan with a monthly payment of $211.37. For the few that graduated with minimal or no student loan debt, kudos to them for being in such a fortunate position. As for the rest of us, the student loan payment will be part of our lives for a while and a sizeable chunk of our income will be dedicated to paying it off. Regardless of the size of this debt, it’s considered to be a good form of debt as it’s an investment in oneself and the interest that we pay is tax deductible.
Based on a recent report from a credit monitoring agency, TransUnion, a typical Canadian owes about $21,686 of consumer debt (this number does not include mortgage debt) as of 2016. While this number is not staggering, it’s still a sizeable amount that can consume a good portion of one’s monthly income. For example, it will take the average person 10 years to pay off this loan with a monthly payment of $283.79 at a 5% interest rate. The total amount of interest paid for the 10 years duration is $7,235.03. Once again, this number is not significant by any means, but if one’s consumer debt keeps on growing and the average interest rate on the debt is more than 5%, the struggle to pay off debt will increase dramatically and the consequence will be a decreased in savings. In the same TransUnion report, the average balance on a credit card is $3,954, which equate to about $786.85 in interest payment per year for a common credit card with a 19.9% interest rate. Now the picture seems clear when credit card companies want to offer so many perks to cardholders to entice them to use their card for purchases. They want to make their 19.9% return.
Before penning this post, I thought that my knowledge of debt and the different products out there in the market was pretty sound. Boy, was I dead wrong when I came across this article about payday and installment loans. I always thought that credit card and department store debt were the two worst culprits in the consumer debt category, but they are far from the worst. The two worst form of consumer debts is payday loans and installment loans. For example, some payday loan offer to lend $300 for a two weeks period and cost the borrow only $20. If we work out the borrowing rate, it cost about 173.33% (=26*[20/300]) on an annual basis. Unfortunately, most people who take out these loans think that it’s still pretty cheap that it only cost them $20 to borrow $300. For the installment loans, the annual interest rate ranges from 46% to just under 60%. The reason that it is just below the 60% mark is because it’s criminal to charge an interest rate of 60% or more for a loan. Criminal. The really sad part about these loans are the borrowers that could least afford these type of loans are the end users and are most likely to be low-income earners and financially stressed individuals.
In 2015, the average size mortgage in all of Canada was approximately $193,778, based on research from LSM Insurance Canada Ltd. As of December 2016, the average house price was $470,661. Based on these two numbers (there is a one year difference, but it’s close enough for discussion purposes), most of Canadian are still carrying a sizeable mortgage debt. Let’s assume that the average amortization period left on the average Canadian’s mortgage is 15 years and the interest rate of 3% annually, that’s about $1,336.46 of a mortgage payment for the average Canadian. Still, this is not a huge monthly payment by any means, however, if we look at the total annual payment, the total about $16,037 in after-tax earnings.
People incur investment debt when they take out a loan and use the total proceed of the loan to either start a business, buy properties or invest in the financial market. Most experts tend to agree that this form of debt is good debt as they have potential to increase your wealth instead of draining it like consumer debt. This form of debt is not new, but in general, it’s easier for people to borrow to spend rather than to build wealth. As a result, this form of debt is seldom discussed and there are not a lot of statistics on this form of debt.
Average Canadian Salary
According to a salary article from Workopolis with data from Statistics Canada, the average Canadian makes just under $50,000 per year. With the personal tax calculator from TaxTips.ca, the lowest amount of income taxed paid per individual per year ranging from $7,725 (15.5% of $50,000) for individuals living in Nunavut to the highest of $11,036 (22.1% of $50,000) for Quebec residents assuming no deductions taken. Hence, the highest average monthly pay cheque is about $3,522 = [(50000-7725)/12] for Nunavut residents to the lowest of $3,247 = [(50000-11036)/12] for Quebec residents.
What About The Savings?
By now, you must be wondering about, “Where is the savings?” The only time that I mentioned the word savings was at the end of the first paragraph. So here it is:
Savings = [Income] – [Debt Payments] – [Living Expenses]
If we do the math for the average Canadian’s monthly savings, we have:
Savings = [$3,247 to $3,522] – [$1,336.46 + $283.79 + $211.37] – [Living Expenses]
Savings = [$1,415.38 to $1,690.38] – [Living Expenses]
If the average Canadian’s monthly living expenses such as food, utility bills, phone and internet bills, transportation and entertainment costs are between $1,415.38 to $1,690.38, then the average Canadian will have zero savings. If the living expenses are higher, then the average Canadian will be in a debt spiral. Even if the average Canadian’s living expenses comes to about $1,200 a month, it’ll only leave the average Canadian about $215.38 to $490.38 in savings per month, which is about 5.17% and 11.77% of the average Canadian’s average income. That number does not factor in discretionary spending such as clothing, electronic gadgets, vacations, etc..
My Two Cents
So with all the statistics related to the average Canadian’s income, student, mortgage and consumer debts, what does it all mean? It means that when you have debt, the creditors have first dip at your income as you have to pay them first until you get rid of them. You need to be first in line to get paid before the creditors. That means you want to pay yourself first! To increase your savings, you’ll have to understand the different forms of debt and how it can cost you a fortune (bad debts) or help you make more money (good debts). So to keep more of your money in your pocket, you’ll have to keep the creditors out.
In The Third Step To Saving A Million Dollars, I will provide some insights on how to compound and grow your savings.