Income, spending and saving

The basics of financial planning will get you a long way

It’s back to school time! My older son has launched off to university for his first year and my younger son started grade 11. I always loved back-to-school - I was a keen student and thrived on a fresh notebook and a new course outline.

As a tribute to a new school year, I am going back to basics with this blog. When it comes to personal finance, knowing the basics goes a long way. The trouble with personal finance blogs is that once the basics have been covered off, writers sometimes veer into more obscure territory and that that can cause confusion. I’ve written 96 blog posts since I launched my blog in February 2022 and I would say that all of them address the basics. Some focus on factual information and some are more emotions-based. But with every post I write, my goal is to provide relevant information and to never, ever cause confusion.

With all of those blog posts behind me, and a bunch of new readers of this newsletter (thank you!), I want to go back to the most important concepts in personal finance. To me, these are:

·      Understanding your income and spending, and setting up a savings plan

·      Knowing what accounts are available and which make sense for you

·      Investing in a simple and low-cost way

For people approaching or in retirement, I would add decumulation planning (how to best take money out of your various accounts, which is the opposite of the savings plan). Of course, there are many other important topics, but you get my drift – the basics are key.

In the nearly four years that I’ve been working with people as a financial coach, I’ve learned a lot about what people need to know and what they want to learn. I’ve also developed a richer understanding of how the basic concepts of financial planning apply to most people. My objective in my work as a coach is to empower people to be able to manage their own finances. Although I develop financial plans for people, the true value is in the education so that they know how to make their own financial planning decisions in the future.

That’s why my blog is so important to me; it’s a repository of helpful and educational information about personal finance and investing that empowers people to make good decisions.  So let’s remind ourselves of what we need to do to be financially secure.

Understand and manage your income

Income, spending and saving. It’s the simple yet slippery world of spending less than you earn, and saving the rest. An easy concept to understand but difficult to execute on. Why? Because most people don’t know their numbers and are guessing about what they can afford…and saving becomes the last priority.

The first number you need to know is your take-home pay. You already know that your salary isn’t what you have available to spend because you have to pay income taxes, but many people are surprised – and sometimes dismayed – by all the deductions. Deductions can include:

·      CPP contributions

·      EI premiums

·      Union dues

·      Group life insurance premiums

·      Health and dental plan premiums

·      Long-term disability insurance premiums

·      Pension contributions

·      Group RRSP contributions

·      Employee stock plan contributions

·      And of course, income taxes.

In some cases, take-home pay can be less than 60% of your salary. If you earn good money and wonder why you still feel a bit strapped for cash, this might be why. When you are planning your spending and saving, you need to be sure you are accounting for all these deductions.

For people who are self-employed, the deductions are fewer, but they deductions don’t happen up front so it is crucial to set aside money for income taxes and CPP contributions throughout the year. This ensures you are living within your means and spending your after-tax dollars. It also means that you won’t get caught without enough money when it’s time to pay your taxes.

It’s one thing to be paid a salary bi-weekly, but it’s another thing to be self-employed and have uneven income. For self-employed folks with a corporation, it’s crucial to figure out how much income you will take from the corporation each year. It’s often best to pay yourself a set amount weekly, bi-weekly or monthly to provide predictability. Knowing ahead of time what your annual salary will be helps with planning, and it instills good spending habits.

For those who have sole proprietorships, payments are probably coming in somewhat randomly, without a steady cadence. This can make it especially hard to follow a plan for saving and spending. Some months you make more than you need, and in other months you are short. To provide some stability, set aside your extra income in the months you earn more than you spend. Having this “slush fund” will allow you to cover the credit card bill in those months when your earnings are lower (or your expenses are higher).

Know what you spend

Again, a simple concept but so many people have no idea how much they spend and on what. If you don’t have a cash flow problem and are saving enough, then fine – you don’t need to know. But for most people, doing a detailed review and tracking of your spending is eye-opening. And instead of feeling like a downer, tracking your spending is super empowering. No longer are you at the mercy of money flowing through your fingers and feeling frustrated that you can’t cover the credit card bill each month. Take back the control. Review your spending in detail and cut the costs that aren’t adding any value to your life. If you have a serious cash flow problem, you might have to sacrificing some things, but for most people just cutting out the stuff that doesn’t bring utility or happiness makes a difference. I worked with a couple who, after wondering where all their money went every month, did a detailed review of their cash flow. Then, they cut a massive amount from their spending and funneled the money to their retirement. They were still living a good life, but now they could target a retirement date and dream about the house in Italy.

If you don’t want to go through the work of tracking your spending, at the very least look through your credit card and bank account statements every single month. And I mean, LOOK through them. Review every transaction. If something makes you cringe, that might be a sign that it’s spending you can cut. You might also discover you are being charged for subscriptions you didn’t remember you had – in my case, I discovered extra Microsoft charges to my credit card for my kids’ video game habit.

Have a saving plan – don’t just wing it

When I meet with clients for the first time, I usually ask about their savings habits. Do they set aside a certain amount every month or do they just save what’s left over? The answer is usually “I save what’s left over” and they don’t know what that amount actually is. That’s incredibly unhelpful when you are trying to reach a savings goal, be it retirement, a down payment, or buying a new car. And it leaves people wondering: am I saving enough? Too much? Can I spend more freely or do I need to eat out less?

If you are young – and by young, I mean in your 20s’ – putting money into savings regularly (and investing it) is the best thing you can do for your future self. The compounding and growth of that money is astounding over long time periods. If you aren’t so young, the benefits can still be powerful, if you consider that you could live to 95.  

For folks with a pension, it can feel tempting to just assume that the pension will be enough and that you don’t need to save anything more. This might be true for very high-income people who have generous pension plans, and it might also be true for people who expect to have a moderate retirement, but generally speaking, unless both people in a couple have pensions, having savings in addition to the pension will make for a more comfortable retirement. Putting money into TFSA – and maybe also an RRSP – needs to be on the table.

If you are already making regular contributions to your savings, don’t forget to review how much you are adding regularly. As your salary increases, so should your savings. When I was 24 and had my first job in a TD bank branch – a job I loved, by the way – I was putting $25 every paycheque into a group RRSP and investing in index funds. By the time I left the bank nearly 25 years later, that number was $600. Every time I moved into a new role with higher pay, I increased my contributions by at least $25. And I never missed the money because I was used to living on less.

For couples who have differing incomes, it’s important to avoid having the higher-income person accumulate all the savings while the lower income spouse adds little or nothing. For one thing, between the two of you, you should be using all of your TFSA room. Accumulating savings evenly also will allow you to spit income more effectively, and this can lower your overall tax bill. This is especially important when you look ahead to retirement. To accomplish this, the higher income spouse can give the lower income spouse funds to put in their TFSA, and they can contribute to a spousal RRSP. However, a higher income earner cannot put their money into a spouse’s non-registered account – the CRA does not like this. So consider having the higher income earner pay more of the expenses, allowing the lower earner add to their savings.

And remember – savings is good, and investing makes it better. But that’s a topic for another day.

Putting it all together

To put a savings plan in place, you need to know your take-home pay and your expenses. The question of how much to put into savings can be approached using one of two methods. The first method is to take your income and subtract your expenses and commit to a regular amount to add to savings that fits with your life. If that number isn’t big enough, cut your spending. The second approach is the work backwards: figure out what the target is (how much you need to have saved to reach your goal) and calculate how much you need to put away every year to get there. Commit to saving this amount and figure out how to live on the rest.

It doesn’t matter which way you do it – just do it.  

Photo by Mathijs Delva on Unsplash.