“The goal isn’t more money. The goal is living life on your terms.” – Chris Brogan
While we all know that saving makes sense, not enough of us are actually doing it. Ever since credit cards were introduced in the early 1980’s, the savings rate in Canada has steadily dropped. In 1980, people were saving about 25% of their gross income. Today, people are saving less than 5% of their gross income towards retirement (experts recommend we save at least 10%). Even more troubling, for most Canadians, their emergency fund is a line of credit or a credit card.
I mentioned in an earlier post that, when it comes to saving, there are five “buckets” that you want to think about filling to create balance and stability. How much you save is entirely up to you: a good rule of thumb is that 20% of your net pay should go to savings. However, I usually recommend that you just save as much as you can – I’ve never heard anyone complain that they’re saved too much but I’ve heard plenty of people say that they could have saved more! If you’re not sure how much you could save, just think about your last paycheque: if it had been $50 less would you have noticed? $100 less? $150 less? At some point you hit a number that makes you anxious; that’s your pain point. Pick an amount that’s close to your pain point but not too close; a number that you’ll notice for a couple of paycheques and then adjust to. The reason I suggest going a little aggressive with your number is that as humans we tend to take the path of least resistance… if you pick a number that’s too high, you’ll notice and you’ll adjust to something lower. But if you pick a number that’s too safe, one you hardly notice, the chances of you adjusting your savings rate to something higher are slim to none. It’s just too much work for most of us when there are so many other, more interesting, things to do!
Once you have your saving number, then these are the buckets you want to fill:
Bucket #1: slush fund
Your slush fund is a pool of money that you use to cover small, unexpected expenses – an unusually high hydro bill, a trip to the vet, a spontaneous dinner with friends or a night out. For most people somewhere between $1,000 and $1,500 is enough for a slush fund. The idea is that you dip into it when things are tight and top it up when things are running smoothly. You want to pick a minimum amount that you will always have in there (trouble starts when the slush pool gets too low) and then add a decent buffer zone. A savings account attached to your chequing account (but not your debit card!) is usually a great place for your slush money because it can be transferred across when needed but is far enough out of the way that you won’t be tempted to dip into it for non-emergencies. This is always the first bucket to fill. Once this one is full, you can start on the others.
Bucket #2: contingency fund
Some people call this an emergency fund but because there’s a superstitious part of me that doesn’t want to manifest emergencies, I call it a contingency fund. Most experts recommend that we have either 3 months of income or 3-6 months of expenses in our contingency fund. For many people this means an amount somewhere between $10,000 and $30,000. That’s a significant amount of money. Realistically, you’re not going to fill this bucket in a few months, it can take 3-5 years to fully fund a contingency fund but once it’s done, you have a great buffer to protect you from the impact of life’s curve balls. A TFSA (Tax Free Savings Account) is a good place for a contingency fund but you should always have it in cash rather than invested so that there’s no risk of it dropping in value right when you need it. You can contribute to other “buckets” while you’re filling this one, to keep everything in balance. Ideally, you’ll also commit about 20% of your savings dollars to building your contingency fund. Once it’s fully funded, you can add what you were putting into the contingency fund into your LTSS bucket.
Bucket #3: Long Term Saving for Spending (LTSS)
This is the bucket where you save for your bigger financial goals. It might be an epic vacation, a new vehicle, education for your children (or yourself) or perhaps a new home or a home reno project. If your time horizon for your goal is longer than 2 years then you can invest the money in something low-risk but if it’s a shorter time-frame you want to leave it in cash. A TFSA is a good place to stash your LTSS savings which should be about 20% of your savings dollars.
Bucket #4: retirement
Experts tell us that we should be saving 10% of our gross income towards retirement but most Canadians are saving less than 5% and many of us are saving nothing at all. Time is your biggest asset when it comes to building a retirement nest egg: the younger you are, the more time you have for your money to grow and the less that needs to come out of your pocket. To put this in perspective: a 20 year old saving $125/week and earning an average of 5% per year can expect to have around $1.1 million at age 65. A 30 year old wanting to hit the same goal would need to save $225/week while a 40 year old would need to save $425/week to get to the same place.
Take advantage of the tax breaks and save for retirement in an RRSP or pension account. If you work for a company with a group RRSP or pension plan, take advantage of any free employer “matching” that’s available to you and also the bonus of being able to save with pre-tax dollars which will help you save more over time.
Ideally about half of your savings dollars will go into the retirement bucket. Try to get as close as you can to 10% of your gross salary without compromising your other buckets.
Bucket #5: short-term savings (aka the fun bucket!)
This is your fun money bucket; a place where you’re saving purely for the joy of spending. Whether it’s concert tickets, lattes, a night away, new clothes or just a bottle of wine this is the bucket you splurge from. Allocating a certain amount of the money you’re saving just for fun makes it much easier to keep yourself motivated. Too often, people feel deprived because they’re saving so hard they’re not spending. This isn’t good because there’s only so long you can rein yourself in before your willpower gives out and you find yourself in the middle of a spending spree. Having a fun account lets you keep everything in balance and lets you have some ‘guilt-free’ spending money. Ideally you would put about 10% of your savings dollars into the fun bucket. A second savings account is a great place to stash your fun money.
The idea of the buckets is that you use them to strike a balance and build a buffer zone that protects you from the full impact of life’s disasters. Putting a little into slush protects you from getting off track due to an unexpected expense while building a contingency fund helps protect you from the financial impact of a job loss, illness or other large expense. Balancing long-term savings for retirement with other long term savings goals means that a) you’ll have retirement savings and b) you won’t need to rely on credit or dip into your other savings to pay for a predictable expense. Finally, having the fun bucket lets you build a pool of guilt-free money that means you don’t have to go without something in order to treat yourself and you’re not tempted to get into debt in order to have it.