Canadians interested in investing, but who lack a big lump sum to get started, should consider using an automatic savings plan, experts say.
Various financial institutions allow customers to make regularly scheduled investments into a wide variety of products, including mutual funds, registered retirement savings plans, registered education savings plans, tax-free savings accounts and high-interest savings accounts.
Automatic savings plans not only make it convenient for people to become disciplined investors, but those programs offer a slew of other potential benefits such as compound growth and dollar-cost averaging.
Peter Aceto, president and chief executive officer of ING Direct Canada, has used automatic savings programs himself and strongly recommends them to the bank’s clients.
“You are paying yourself first,” Aceto said. “Your lifestyle grows accustomed to saving. It is very, very good
Additionally, the program is easy to use, he said. Clients can choose to contribute on a weekly, biweekly or monthly basis. Next, they pick an amount they can afford and that money is automatically drawn and invested on a regular basis.
For its part, ING Direct offers automatic savings programs for mutual fund accounts, high-interest savings accounts, tax-free savings accounts and RRSPs. Aceto estimates that 30 per cent of the bank’s clients use automatic savings programs.
“We have no minimums because we think that people need to save no matter what,” said Aceto. “Whether it is $10 a month or $10 a week or $50 a month, it is a great way to start.”
Consumers who are shopping around for an automatic savings program should make sure they choose a financial institution that does not require minimums or fees.
The biggest hurdle to getting started, however, appears to be acquiring the initial discipline to invest or save on a regular basis. While it may seem like a daunting challenge, Aceto argues it can involve just simple changes to a person’s daily life.
“Look at what Canadians spend on certain things every day in terms of waste,” he said, noting most people could begin to save just by making coffee at home.
“There are a lot of things that we do during the day that would allow us to save $100 or $200 every month. And having the financial discipline to set up an automatic savings program can really, really force that hand.”
Moreover, building a healthy nest egg through regular contributions is a wise strategy during these difficult economic times. While the Bank of Canada predicts the economy is on the mend, the recovery is considered fragile.
Some economists predict the unemployment rate could continue to rise until mid 2010. Moreover, interest rates could begin increasing from their historic lows by mid next year.
“People who have savings can absorb changes like that a lot better. People who have less debt can absorb changes like that a lot better as well,” said Aceto.
The Bank of Montreal is also a proponent of regular investing and saving. BMO, however, calls its program a “continuous savings plan.”
Emmanuel Hergott, divisional sales leader at BMO Retail Investments, says continuous savings plans can be attached to a variety of accounts, including RRSP, RESP, TFSA and non-registered accounts.
That’s because clients’ long-term goals can be as diverse as saving for retirement, a rainy day, renovations, a wedding or even investing for their children’s education.
“Most Canadians tend to have their paycheques deposited on a bi-weekly basis. So to me, that is the starting point of the conversation,” Hergott said.
There are a number of potential benefits to using a continuous savings plan. They include convenience and compound growth.
Tax-free savings accounts, meanwhile, allow investments and savings to grow tax free. And spreading out RESP contributions is a less painful way to reach the ideal contribution amount of $2,500 per year.
Also, those who make regular RRSP contributions avoid the last-minute rush and panic associated with scrounging up a lump sum or borrowing funds before each year’s deadline. Regular RSP contributors may also have the opportunity to pay less tax during the year, BMO says.
“By notifying Canada Revenue Agency of your regular RSP contributions, you can pay less tax throughout the year instead of waiting for a tax refund,” the bank says on its website.
“Pick up a tax deduction waiver to notify your employer to deduct less income tax from each pay cheque.”
Dollar-cost averaging on certain investments is another possible benefit of regular investing.
“In layman’s terms, dollar cost averaging really works out to doing what we do when we go to the grocery store,” Hergott said, noting it is comparable to buying products on sale. “If they are on sale, I can buy more of them.”
That means when markets are down, an investor can buy more units of an investment vehicle, like mutual funds or stocks, with the same dollars.
Steve Geist, president of CIBC Asset Management, says the earlier a person starts saving and investing, the better.
“Unfortunately, when the opportunity to get started early is right there, it is certainly not top of mind,” he said, adding younger Canadians are often more focused on just living life.
“It is hard to get somebody, who realistically, retirement might be decades down the line, to think about some of these things.”
Younger Canadians, however, should be looking to maximize the benefits of having a longer saving and investing time horizon.
For instance, if a person has a goal to save $500,000 by age 65, the earlier they start, the easier it is to reach that goal.
If a person starts a regular savings program at age 25, he or she will need to save $201 a month to reach that goal – assuming an annual return of 7 per cent. Over that 40-year period, the person’s contributions of $96,480 would have an investment growth of $403,109. That means the total amount of the investment would be $499,589 at age 65.
But if that person waits until they are age 55 to start making regular contributions, he or she would have to save a whopping $2,907 a month (also assuming a 7 per cent annual return) to end up at roughly the same place.
In this case, the client’s contributions of $348,840 would have an investment growth of $151,219 over a 10-year period. That means the total amount of the investment at age 65 would be $500,059. With those examples in mind, Geist says Canadian youth should focus on saving what they can now even if their first jobs don’t come with fat paycheques.
“Twenty years later, while you might make twice the money, you’ll have a mortgage payment and kids and all sorts of things,” he said. “You may have less idle cash in your forties than you do in your twenties.”