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financial facelift

Marika and Peter are 21 and just starting grad school. When they emerge two years hence as software engineers, they plan to marry and buy a small house or condo, and a car.

In the meantime, they are living together and bringing in a combined $75,000 a year from scholarships, research grants and work, he as a research assistant, she as a teaching assistant. When they graduate, they expect to earn a starting salary of $55,000 each.

What distinguishes them from many other 21-year-old students is that they have $60,000 in the bank, savings Marika set aside from working during her undergraduate years. This year and next, they will each contribute $5,000 to their tax-free savings accounts. When they start working, they plan to live on one salary and take full advantage of the registered retirement savings plan.

They plan a simple wedding costing about $4,000 followed by a "shoestring" trip to Europe for $4,000 or $5,000.

Marika wants to put her savings to work for the next few years "so that I will have enough money to deal with the expenses of becoming an adult, whatever they may be," she writes in an e-mail.

We asked Warren MacKenzie, president and chief executive officer of Weigh House Investor Services in Toronto, to look at Marika and Peter's situation. Weigh House is a fee-only planning firm that does not sell investments.

What the Expert Says

Marika and Peter are excellent models for young adults who want to enjoy financial security during their working years and financial independence in retirement, Mr. MacKenzie says. They will succeed because they are addressing a number of important money management principles.

They are taking responsibility for their finances, choosing to live modestly and saving a portion of all they earn. Because they plan to live on one salary when they start working, if they decide to have children, Marika will be able to take some time off without upsetting the family finances, he says.

First, the investment question. Marika and Peter plan to draw on their savings in two or three years - perhaps to tide them over until they find work, to cover the cost of moving to a new city, to buy a car or some furniture or even as a down payment for their home. With such a short time horizon, they should keep their money in a high-interest savings account or in guaranteed investment certificates, Mr. MacKenzie says.

"When cash is going to be needed within a three-year period, it would be a mistake to try to earn the higher rate of return that might be possible with equity investments." Besides, the higher returns promised by the stock market are in no way guaranteed.

Longer term, they can learn about financial markets by investing in one of their TFSAs in a diversified, "couch potato" portfolio of exchange-traded funds, Mr. MacKenzie suggests. By monitoring their portfolio and rebalancing the mix annually, they will learn the basics of investing.

"They can make their mistakes with a small amount." Then, if they decide to manage their own investments, they will be better informed and will have the confidence to do so.

Marika and Peter figure they'll have to pay about $240,000 for a small house or condo, preferably in their home town of Halifax if they can find work there. If they work for a while before they buy, as they plan, they can stash away some money in their RRSPs. They are thinking of using some of this money for a down payment under the federal government's Home Ownership Savings Plan.

Mr. MacKenzie estimates that with $20,000 down, 5-per-cent interest and a 25-year amortization, their mortgage payments will be about $1,280 a month. They will have additional costs for insurance, utilities, maintenance and property taxes, so their living expenses will be higher.

He recommends they use three-quarters of their savings to pay down the mortgage as quickly as possible, putting any surplus income into their TFSAs, RRSPs and insurance policies.

If and when they have children, Peter and Marika will need inexpensive term life insurance to replace income if one of them should die, Mr. MacKenzie says. Because they are young, they might want to consider whole life insurance as a long-term investment.

"At this age, whole life is inexpensive, earnings increase on a tax-free basis and the growth in the cash surrender value of the policy can eventually be used to fund their lifestyle," he notes. The death benefit can be used for estate planning purposes.

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The People: Marika and Peter, both 21

The Problem: How to invest $60,000 in savings and set finances on course for marriage, careers and the purchase of a home.

The Plan: Invest in short-term liquid securities such as GICs because the time horizon is fairly short. Put savings in TFSAs for now, adding RRSPs to the mix when they start working. After buying the home, pay off the mortgage as quickly as possible.

The Payoff: Lifelong financial security and the peace of mind it brings.

Monthly net income: $4,500

Assets: Bank accounts $15,000; GICs and term deposits $42,000; TFSA (mutual funds) $5,000. Total: $62,000.

Monthly Disbursements: Groceries, dining out $600; clothing $50; medical, drugs, dental $50; rent $1,100; telecom, TV $110; furniture, appliances $50; entertainment $50; tuition $1,260; bus $20; gifts $20; miscellaneous $100. Total: $3,410. Savings Capacity: $1,090.

Liabilities: None



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