This article profiles Margaret and John, a couple with a combined annual income of $244,000 but lacking in financial literacy. Their situation demonstrates why financial literacy is an important life skill which has tangible effects on one’s standard of living.

Appropriate Subject Area(s):

Personal finance, investing, financial literacy.

Key Questions to Explore:

• What steps can Margaret and John take to improve their financial literacy knowledge?
• What are the pros and cons of hiring an investment adviser?
• What are the benefits of setting up a TFSA?
• Why is it advisable for Margaret and John to invest in dividend-paying blue-chip stocks?
• What are the benefits of setting up pre-authorized savings deposits?

New Terminology:

Defined benefit pension, TFSA, RESP, RRSP, dividend, blue-chip stocks, ETF and mutual funds.

• Defined benefit pension: this is an employer-sponsored plan which specifies either the pension benefits to be received by an employee or the method of determining those benefits. In this article, John is entitled to a pension of $45,000 and Margaret is entitled to $80,000.
• TFSA: a tax-free savings account is a flexible investment account which enables Canadians to earn tax-free returns on their investments. These help Canadians meet their short- and long-term goals because withdrawals and investment returns are tax-free.
• Dividend: a dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.
• Blue-chip stocks: these are the stocks of large, well-established and financially sound companies that have operated for many years. A blue-chip stock typically has a market capitalization in the billions, is generally the market leader or among the top three companies in its sector, and is usually a household name. Wal-Mart, Microsoft, ExxonMobil, and Johnson & Johnson are examples of blue- chip stocks.
• ETFs: an exchange-traded fund is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
• Mutual funds: a mutual fund is an investment vehicle made up of a pool of funds collected from many investors for investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors.

Materials Needed:

A copy of the article.

Introduction to lesson and task:

Margaret and John are well-paid individuals in the media and communications industry. However, due to their lack of financial literacy they have been unable to save and invest their income in ways which will maximize their returns and enable them meet other financial responsibilities like household improvement, retirement and financing their children’s education.

In this article, Ms. Heather Franklin, an investment advisor, gave the couple the following pieces of advice based on their unique situation:

• Transfer existing funds from regular savings to a TFSA: Margaret and John currently have $50,000 in their savings account. The interest they earn on this amount is taxable. However, if they transfer a portion of this amount to a TFSA, their investment returns from this account will become tax-free. Note: Margaret and John have a combined unused contribution room of $104,000.
• Invest in diversified ETFs, low cost mutual funds, and on dividend paying blue-chip stock: The rationale here is to invest in relatively safe, liquid investments, which also provide the potential of earning high investment returns. ETFs and low cost mutual funds are less risky than individual stocks due to diversification.  Blue-chip dividend stocks are also generally less risky because blue-chip companies are generally reliable, and the dividend payouts they offer enable investors to take advantage of compounding.)
• Consider GICs: in general, guaranteed investment certificates offer better returns than a savings account. The drawback is that the funds may not be available for withdrawal when you want them
• Seek lower cost investments: Margaret and John’s RRSP account currently holds mutual funds with high management expense ratios that are “handicapping the performance of their investments.” Investing in the lower cost alternatives will increase their investment returns.
• Open a self-directed RESP (registered education savings plan). Margaret and John’s savings for their children’s tuition is underfunded by approximately $102,000 ($160,000-$58,000). It is advised that they open a self-directed RESP at a brokerage firm and invest in stocks as well as bonds to generate higher returns. They should also take full advantage of the Canada Education Savings Grant.
• Set up an emergency fund: an emergency fund will enable Margaret and John to cover at least three months of living expenses, in the case of an emergency. For example, if one or both lose their job(s).
• Set up pre-authorized deposits: automatic transfers to savings accounts will enable Margaret and John to develop the habit of spending less and saving more.
• Increase financial literacy knowledge: it is essential for Margaret and John to increase their financial literacy knowledge because doing so will enable them make optimal personal finance decisions, and gain a sense of control of their financial destiny. Whether they ultimately decide to hire a financial advisor or not, this skill is needed to ensure that their investments are aligned with their financial goals and aspirations.

Note: Financial literacy not only affects individual’s personal finances, but it also affects an individual’s well-being. In this article, Margaret states that she is “starting to lose some sleep” over the state of her personal finances, even though her family is relatively in good financial shape. This sentiment highlights the importance of teaching students about financial literacy from an early age. Financial literacy will enable students to make sound financial decisions and improve (or maintain) the quality of their lives.

Action (lesson plan and task):

• Ask your students, once they have read the article, to explain how a lack of financial literacy has affected Margaret and John.
• Ask your student to state ways in which Margaret and John could increase their financial literacy.
• Ask your students to explain how a defined benefit pension plan works.
• Ask your student to state the benefit of owning a dividend paying blue-chip stock.
• Ask your students to state the differences between a TFSA and an RRSP.
• Ask your student to explain how an RESP works.
• Ask your students to indicate by show of hands if they prepare weekly, monthly and yearly budgets.
• Ask your students to describe how to develop a budget.
• Ask your students to describe their saving and/or investing strategy.
• Ask your students to explain how a pre-authorized savings deposit works.
• Ask your students to indicate by a show of hands if they have set up pre-authorized savings from their chequing account to a savings account.
• Ask your student to state what they like or dislike about the pre-authorized savings feature.
• Ask your students to state why it is important to begin budgeting, saving and investing from an early age.

Consolidation of Learning:

• How to calculate TFSA contribution room

TFSA: An individual’s contribution room is the maximum amount that individual can contribute to his/her TFSA without incurring a penalty. TFSA contributions room accumulates every year (beginning from 2009), and it is available to resident individuals 18 years of age or older. Unused contributions are carried forward indefinitely, and withdrawals restore previously used contribution room.

Note: Since Margaret and John have not used any of their contribution room the entire $52,000 is fully available to them. Thus they have a combined contribution room of $104,000 as stated in the article.

Success Criteria:

• After completing this lesson plan, your students should understand the benefits of financial literacy and they should also be aware of new avenues to increase their financial literacy knowledge.

Confirming Activity:

• Ask your students to state whether they believe Margaret and John should hire an investment adviser or set up a plan that does not require micro-management.