So far in this series on personal finance, we’ve outlined the 6 steps that are the foundations of personal finance. We’ve showed the importance of monitoring your net worth and cash flow, then we built a solid foundation by developing a cash flow surplus, setting aside an emergency fund, giving to charity, and developing a plan to pay off debts. Now it’s time to start building on that foundation by expanding on the basics.
Expanding on the basics involves the following:
- Paid off non-mortgage debts; No new debts:
The simple advice here is to commit to no new debts and continue your debt repayment plan on all non-mortgage debts. You’ve begun the debt snowball or debt avalanche and you need to make sure you don’t give yourself more debt to pay off and keep the momentum going with your debt repayment plan.
- Grow the emergency fund to 3-6 months living expenses:
In step 2 of our plan we established an emergency fund of $1000 and now it’s time to grow that fund to be enough to cover 3 to 6 months of living expenses. For this you’ll need to go back to the beginning and figure out your annual expenses. You will need to save 25-50% of your annual expenses so that you’ll have access to those funds in case of emergency. For example; car repairs, house repairs, health issues, or anything else that’s bound to come up from time to time. This will also help ensure you don’t go into debt the next time something unexpected pops up.
- Make sure your life insurance is adequate:
Life insurance isn’t a very fun conversation but it is necessary for many people. I have a simple rule when it comes to life insurance for most people and that is the 2 D’s of insurance: Debt and Dependents. If you have debt or dependents then it is likely you need some life insurance. The reason being that if you meet with an untimely demise, you don’t want to saddle those you leave behind with any of your debts and you want to have a solid plan to provide for any of your dependents until they are able to be self-sufficient. Some simple math does the trick here to figure out how much life insurance would be appropriate, so you need to add up all of your debts and then figure out what it would cost to provide the necessities of life to your dependents. For example, if you have debts of $350,000 and 2 children aged 2 and 5 who need $20,000 per year each until they are 22 years old then you’ll need $350,000 + ($20,000 * 20) + ($20,000 * 17) which equals $1,090,000. For most people, you can easily take care of that insurance need by applying for term insurance which is the least costly way to insure a need like this. Some situations are more complicated so it is wise to seek professional advice from a trusted Financial Planner who has experience and expertise with insurance.
- Make sure you have a valid will:
A will is a legal document that lets the world know what your wishes are when you die. Hiring a notary public or a lawyer is wise, and for a relatively small amount of money you can get this document complete within a couple weeks. For more extensive commentary on why you need a will take a look at the below article written by The Wealthy Barber, David Chilton. https://ca.rbcwealthmanagement.com/eddy.mejlholm/blog/2099320-The-Wealthy-Barber-Get-an-up-to-date-will
- Save at least 10% of your total income for retirement
Up until this point we’ve focused all of your surplus cash flow into debt repayment and taking care of some basic things like establishing an emergency fund, getting insurance, and a will. Now we will turn our attention to planning and preparing for your future. This means saving for a day when you are no longer willing or able to work for a living. Most of us will be eligible for some government benefits like Canada Pension Plan and Old Age Security but this is rarely enough to provide what most people have for their basic needs never mind their desired lifestyle! Later we will focus on calculating the amount you’ll need to be saving to reach your goals but now we are just going to start with saving a simple 10% of your total income. Many people get stuck at this point with determining the right place to save. Should I save in a Registered Retirement Savings Plan (RRSP) or a Tax Free Savings Account (TFSA) or some other way. Here’s a general rule that you can follow for now (2019 info):
- RRSP if income is over $53,000 / year
- TFSA if income is under $48,000 / year, especially if you have a pension
The reason for this income-based distinction is because of income taxes and the different tax brackets the CRA has established. More info on tax brackets here: https://www.ey.com/ca/en/services/tax/tax-calculators
If you want to invest your savings into a diversified portfolio or just into a savings account then go for it. Right now the focus is to get in the habit of savings a regular and proportional amount of your income for the future.
We’ve made great progress and next time we’ll take a look at the next step and start looking at strategic planning to build even further on the solid foundation and structure you’ve built so far.