Will a higher income solve debt problems?
If you struggle with finances, you may think that a more lucrative job is the solution to your struggles. But a larger paycheque doesn't guarantee a good credit score, according to financial experts. Seemingly well-to-do Canadians can face challenges with managing their debt loads too.
"Earnings are an indirect factor, but there are many other considerations that determine credit scores," explains Patricia White, Credit Counselling Canada's executive director. She adds, "Someone with a lower income may have an excellent credit score because they pay their bills on time, use a reasonable proportion of their credit limit and avoid owning an excess number of credit products. Higher earnings can mean more available credit, which may lead to more indebtedness."
Some hard numbers appear to support that assertion. According to Statistics Canada's Household Debt in Canada study, the average debt for households earning $100,000 or more was $172,400 per borrower in 2009. That figure is higher than the debt of the average Canadian family. High-income households represent 31 per cent of the population, but 37 per cent of all debtors.
Tina Tehranchian, senior financial planner and branch manager with Assante Capital Management Ltd., shares her insights about whether the top earners she counsels are impervious to borrowing troubles.
Q. Have you encountered high-salaried people who were poor money managers?
Tina Tehranchian: Yes, very much so. Having a big paycheque is not an indicator of net worth at all. I've seen in my practice many clients -- mostly professionals -- with high six-figure incomes but who had very high debt levels. They have no proper cash flow management. A lot of times, their spending is higher than what they bring in, which creates a deficit for them and sometimes a negative net worth.
In contrast, there are clients who have had very modest incomes all of their lives, but have been very prudent and disciplined when it comes to spending. As a result, they have significantly higher net worth than the high earners who do not want to defer their spending. At the end of the day it doesn't matter what you earn. What matters is what you save.
Q. What are root causes for inadequate retained earnings and savings?
Tehranchian: Psychology has something to do with it. Sometimes it's keeping up with the Joneses, sometimes it's just not thinking about tomorrow. But what it boils down to is poor cash flow management. Your spending impacts that in a significant way.
For example, I know this couple who have been my clients for over 20 years. When I initially met them, they were both professionals in their early 40s. They were making very high double-digit income, but were living in a rental apartment, didn't own any property, were in debt up to their necks and really didn't have any significant assets. This was despite the fact they had dream jobs and incomes that most of us would envy.
The financial planning process really helped. Once we sat down and they looked at their financial situation on paper, and also examined their financial goals and what they had in mind for when they wanted to retire later on in life, that really helped focus them. In less than 10 years, they managed to totally pay down their debt, buy a beautiful home and significantly increase their RRSP contributions. Only a couple of years ago they retired with a very comfortable guaranteed stream of income.
Q. Do top earners have less time to focus on their personal finances?
Tehranchian: Obviously, an entrepreneur, business owner or a professional would have a more hectic schedule than an employee who has a 9 to 5 job. A couple of years ago, I had a case where one professional with a six-figure income had to declare bankruptcy because the bills had mounted so badly. There were a number of setbacks, but basically she forgot to pay her bills and missed too many deadlines.
Q. Does post-secondary education enable debt?
Tehranchian: Advanced degrees are definitely expensive, but I don't think the cost of education is the problem. I'm a big believer in higher education, and think that an MBA degree is worth the investment.
The problem happens after you earn the MBA. As a professional, you vie for a certain lifestyle that includes expensive cars, fancy restaurants and costly homes. All of these things mean more and more debt. If you do not manage debt properly, it can easily get out of hand.
I have clients who are business owners who lead very modest lifestyles. They might have a business in the construction industry, so nobody expects them to wear expensive clothes or drive expensive cars. Instead, they put all of their savings into their businesses, real estate and their homes. Those are investments that increase in value.
Q. What key pieces of advice would you give on controlling debt?
Tehranchian: Start your financial planning with cash flow management. When you write out your cash flow, figure out exactly what you're spending now. Have a goal for each category that records what you think you should be spending. It's one of the most enlightening exercises that I personally went through and I make sure all my clients do too.
It's really worth spending time and figuring out exactly where your money is going -- rather than where you think your money is going.See related: How to find a good credit counselling agency; 7 surprising facts about your credit score
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