5 big trends that will affect your finances

Posted on 06. Oct, 2010 by in News

Published On Wed Oct 6 2010, Don Drummond, the star.com

Canada’s economy has rebounded strongly from the recession and the recovery should continue albeit at a less robust pace. Canada has made impressive job gains and Canadians are feeling more confident. While interest rates are starting to head up, they aren’t likely to rise much above these historic lows. Yet while all these signals seem to add up to a powerful incentive to keep borrowing and spending, it is more than ever a good time to do just the opposite.

Low rates and modest market returns make the whole idea of saving less attractive. Why bother to put something aside when returns are low to non-existent on such things as GICs and savings accounts? Stock market returns are also limited as the global economy emerges from recession with slow growth and debt woes in Europe and the United States. Worries about inflation down the road have some emerging economies switching gears to restrain growth which also acts to reduce returns by dampening growth, profits and commodity prices.

But if all this seems to point to a good time to head to the mall, try and resist the temptation. Instead, we should be thinking about longer-term considerations and these are all signaling save.

Here are five trends to consider:

1. We’re deeply in debt

Canadian household debt expanded at a 9 per cent annual pace over the past decade, with 8.6 per cent growth in mortgages and 9.7 per cent advances in consumer credit such as credit cards, personal loans and lines of credit. The pace of debt growth doubled the increases in after-tax incomes. Households have never been so indebted relative to either income or assets. This leaves them vulnerable to interest rate hikes, house price declines or equity market corrections. Last year, 6.5 per cent of Canadian families allocated more than 40 per cent of their income to servicing their debt. This will rise if the pace of debt accumulation continues and as interest rates go up. Consider that each percentage point rise in interest rates adds $2,000 onto the annual servicing cost of carrying $200,000 of debt. Further, the debt loads leave households unprepared for the financial needs they will face in future. That is where the attention should be focused, even if the current economic and market conditions scream spend.

2. The bills continue in retirement

Maintaining one’s standard of living through retirement typically requires an income of 60 to 70 per cent of that received during the working years. TD Economics estimates that 20 to 25 per cent of Canadian households are not saving enough to generate that kind of income in retirement. The problem is concentrated among middle-income households, particularly where there has not been access to an employer-sponsored pension plan and little has been set aside on their own. Of Canadian households where the primary earner is 55-64 years of age, only 65 per cent have a RRSP and only half of those have more than $55,000 in their account.

3. The $100,000 university degree

Most families now need to save from a child’s birth to pay for a post-secondary education. If your child was born this year, when they’re 18 and heading off to university or college, a four-year program for a student not living at home will cost almost $100,000 in today’s dollars. With two children, the education saving requirement is huge and increasingly competes with retirement savings. The median age for a Canadian woman to have a first child is now 30, meaning that many couples are in their late forties and fifties when their children are in higher education. These are typically the years when families should start to amass considerable savings for their pending retirement. Instead, they’re needing to divert a portion of this cash into higher education.

4. Compressed earning life

People are starting full-time work later in life because they’re staying in school longer. Until recently there has been a trend toward earlier retirement. So the period over which savings can be amassed is being compressed and yet people are living longer. In previous generations there were typically fewer years in retirement than in work. Now it is not unusual for someone to work 35 years, retire at 60 and live 20-35 years in retirement. Clearly this latter scenario requires a much higher savings rate over the work years.

5. A cooling housing market

Canadians shouldn’t count on the sorts of gains in the value of their homes that they’ve seen in the past decade. Between 2000and 2010, the value of an average Canadian home rose by 8 per cent annually, above the general rate of inflation. The historic norm is more like 2 percentage points above inflation. Before we get back to that rate, it is likely we’ll go through a period of no growth, or even a decline. In the longer-term, in a low inflation world with modest growth dictated by an aging population, the gains in all assets, including housing, fixed income and stocks is unlikely to be more than 4 to 7 per cent a year. This compares unfavourably to earlier decades when investors could get higher nominal rates of return from simply investing in low-risk government debt products.

Current economic and market conditions may continue to turn Canadians away from saving. After all, how appealing is it to save and invest when rates of return are likely to be modest? But Canadians are going to have to get used to this. The savings must be done. Now is the time to start.

Don Drummond recently retired as Chief Economist of the TD Bank. A former Associate Deputy Minister of Finance he is a visiting scholar at the School of Public Policy at Queen’s University.

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