Five Tips for Getting Started on your Financial Journey
If you’ve listened to my podcast you may remember that my wife Robin and I have three kids. Two have already graduated from university, and our daughter, the baby, is going into her third year. Whether they like it or not, I am pretty vocal about the importance of putting good financial habits into place early on and I’m not shy about letting them know my thoughts. I’m not sure if that’s the parent or financial advisor in me – or maybe a bit of both.
When you first start making money, it’s exciting. Exciting to have your own money and exciting that you can decide how you want to spend it. You might still be living at home and have low expenses, or you might be out on your own and need to make ends meet. Regardless of your situation, there are things you need to do to set yourself up for success. Here are my top five tips that will get you on the right track.
#1. Pay yourself first!
Nothing impacts your long-term financial success more than having a solid savings strategy and paying yourself first is the best way to achieve this. This means designating a certain amount of your monthly income to pay yourself before you pay your bills or anyone else. The amount can be $50 a week, $100 or ideally, at least 10% of your paycheque.
Here’s an example of just how powerful an impact this can have. $100 a week at 6% will grow to over $200,000 in 20 years. Save $200 a week and you’ll have over $400,000! Most people pay all of their bills and expenses first and then tend to spend whatever is left, which leaves them with little or nothing to show for it.
To get started, set things up automatically so that the money you allot to pay yourself goes directly into your savings each month. In my opinion, this is the single best thing you can do to build your wealth.
#2 Spend less than you earn
An obvious one I know, but frankly, this is one that trips up a lot of people, particularly because interest rates have been fairly low for some time and credit is easy to get.
Even if you are quite disciplined with your spending, the only way to truly stay on track of your inflows and outflows is to create - and of course, stick to - a budget. Here’s a high level explanation of what you’ll need to do. For more detailed information, check out my blog or podcast on the topic.
Write down all of your expenses in categories. Start with the living essentials. That’s food, shelter and utilities, basic clothing, and transportation. After you’ve got all the essentials covered, continue listing out the rest of your monthly expenses. Be proactive and look ahead– do you have any larger expenses coming up? What about vacations or birthday presents? Include entertainment and eating out. And don’t forget to plug into your budget an expense category called savings. This is part of the “pay yourself first plan”. Add everything up and subtract it from your after-tax income. If you find there is nothing left or you are over your budget, you’ll need to revisit your expenses and pare back on some things.
#3 Save for a rainy day -- because sometimes it pours
Build up an emergency fund. Things will go wrong and can send you into a tailspin pretty quickly. It’s not fun to plan for car troubles, breaking your phone or getting laid off, but these things happen and usually at the worst possible time. By having a buffer in place, you’ll not only avoid a lot of mental anguish but more importantly you will be a lot less likely to get into a downward spiral of debt. I personally like the idea of having a minimum of three-times your monthly fixed expenses saved. Ideally you should aim for six months. That way, should something unexpected happen, you can access the money you need and give yourself some time to get back on course.
#4 Avoid bad debt
What exactly is bad debt? Very simply, bad debt typically has a high interest rate on something that is depreciating in value. Basically, if you are paying someone else money so that you can have something you otherwise couldn’t afford, that’s typically not a good idea. You know those payment plans for appliances with super high interest rates? Never a good idea! Not paying off your credit cards each month is another example of bad debt. The exception to this rule would be a mortgage because let’s face it; there aren’t too many people who can afford to buy a house outright. At least when you take on a mortgage you’ll be paying a fairly low interest rate on an asset that is likely appreciating in value.
One of the biggest problems with debt is that it’s easy for it to snowball and get out of hand -- so get in the habit early of living within your means.
#5 Take advantage of tax-free investment vehicles and matching programs.
Taking advantage of tax sheltered growth is a really smart investment strategy. These come in the form of either a tax-free savings account (TFSA) or a registered retirement savings plan (RRSP). What’s the difference between an RRSP and TFSA and what should you go with? Let me give you a quick explanation of how each works:
You can invest up to 18% of your income to a max of $26,500 a year in an RRSP, allowing you to reduce your taxable income and grow any investments tax sheltered. It’s important to note that an RRSP does not provide a permanent shelter from taxation, but rather defers income tax payable until a future date. This means that at some point you will withdraw money from your RRSP and when you do, that money will be taxed. Arguably however, by that time you’ll be retired and therefore in a much lower tax bracket. In the meantime, because you won’t be paying any tax on the income or growth of returns, your wealth can grow more quickly.
With a TFSA, you can invest up to $6,000 a year and you’ll never have to pay any tax on your savings OR on the money it earns. Pretty amazing. If you are in a lower tax bracket and don’t need a tax-reduction strategy, you should consider maximizing your TFSA before you RRSP.
Finally, if you work for a company that offers a group RRSP you should pay attention. This is a great perk that’s designed to encourage you to save at work by contributing through payroll deductions.
Here’s a quick example: Say your company has a dollar for dollar plan for 5% of your earnings to a maximum of $100,000. That means if you put in $5,000, they’ll put in $5,000 to your RRSP. Their contribution is a taxable benefit to you, but you’ll get a tax deduction for the full $10,000. That’s right, all contributions (both yours and your employers) are tax-deductible to you – and all investment earnings are tax-sheltered. And if you leave the job, the group RRSP money isn’t locked in. It’s yours and when you leave, you can transfer is to your own individual RRSP wherever you happen to hold it.
And there you have it. My top five tips to get you started on a successful financial journey. If you don’t feel confident when it comes to money matters, meet with a financial advisor, money coach or a mentor you trust. The worst thing you can do is avoid getting started.