Simple Finances

When it comes to finances you can most likely divide your spending into 3 areas:

1. day to day spending (your budget)
2. paying down debt (good and bad, short and long term)
3. savings (emergency, RRSP- retirement, RESP- education, travel, taxes)

So how do you tackle all of these areas?

Budget

First, you need to determine your day to day budget. If you are spending without any guidelines chances are you are going way over budget. I recently calculated how much we actually spend on groceries and it was 50% more than budgeted! This is because we would pick up things as we needed them and we bought lots at full price for this reason.

A budget for food and spending allows you to carefully choose how you spend your money. And a meal plan helps with this. Meal planning will help you avoid food waste (and therefore $ waste), will help you use what is already in your pantry, will help you plan a few frugal meals, and will help you avoid last minute take out).

The most simple step is to make a reasonable budget. And every week or two weeks you visit the bank to withdraw for food, spending, restaurants, activities, wine, transportation... whatever is in your budget that you need to purchase regularly. If you don't trust yourself then use a cash system like this and fill envelopes with the money. Take only what you need that day and leave the rest at home.

If you have leftovers then you can either keep squirrelling it away in the envelope to treat yourself. Or you can take out less the next week and put the surplus towards debt or savings.

Once you have this under control, the next step is debt repayment.

Paying Down Debt

Just for sanity's sake at the same time you may want to build an emergency savings fund (see below).

Years ago my friend told me he had $10,000 in savings. Then almost in the same breath he admitted he had $10,000 in credit card debt. Hmmm, talk about a psychological trick you can play on yourself. There is little chance his savings earned more interest than his debt charged. So he was losing money as he went along.

You need to pay off your debt before you can save or you will still be spending needlessly on interest.

How do you do this? Well there are different techniques. And sometimes a psychological benefit can outweigh the cost. But I find the most simple is to start with highest interest rate first and go from there. And start with bad debt and go from there too.

By the way bad debt is for something that depreciates in value. So certainly credit card purchases like clothing would fit here. And also realistically a car loan would too. But if your car loan is only 1% interest you may leave this till the very end.

But! If you have some small credit card balances that can be paid off quite easily, then definitely do those first. As soon as the balance is paid off you will stop paying interest. So that is a simple solution. And when those little cards are paid off then cut them up and close the account. In the end you should only need 1 credit card.

Logically you would pay off debt in this order: high interest small credit card bills, high interest big credit card bills, overdraft, line of credit, student loan, car loan (if very low interest), mortgage.

Other debt to consider would be a family loan- use your discretion and talk to the family member to come up with a plan you can both agree on. And perhaps investment loans- this is probably best left to the advice of your accountant.

So when does it make sense to pay off the mortgage fast? I think this is a personal decision. You can blaze along and pay off asap. Or it may make more sense to use your RRSP (retirement savings) contribution first. Other options include using your tax return to make an extra payment, doing the allowed extra payments (some are limited to 1-2 per year or up to 20%), or changing to bi-weekly rather than monthly. All these options can take tens of thousands of dollars off the total interest payment over a 25 year amortization.

Savings

This section is a balance of personal goals, practical decision making and pychological satisfaction.

The first step is to build an emergency savings fund. Realistically a line of credit is for emergencies. But having been through the process of using my line of credit when starting a business I can tell you this can be a huge psychological burden. An emergency savings fund can be used for unexpected house and car costs or for day to day costs if you lose your job. Ideally you would build to 6 months of day to day spending (including bills and your mortgage etc.). But baby steps are fine. Start with $100, then $500. Then build from there. A little bit every month.

Then you may want to consider savings for taxes if you are self employed. You don't need to go crazy, but if you have a sense of how much you will owe then start to put it aside every month.

Next may be RRSPs (retirement). But likely only if your income is in a high bracket and it will make a big difference. If you are still not making tons of money then consider saving your limit for when you are making more money.

If you have children consider RESP's. In Canada the government will give you 20% more in grants to a maximum of $500. So planning for $2500 per child per year is ideal. The government grant maxes out at $7200 (some time in your child's teens if you start early). This is a great way to start to prepare for your children's education. Better yet, convince grandparents to contribute too. You can get one year behind- so if things are tight at first then you can play catch up. And please, don't feel pressure to contribute if you are in debt. Pay yourself first!

Also keep in mind savings for other important areas. If you are travellers then decide what your travel plans are and set a monthly savings amount. If you know you want to buy a car then do a monthly savings amount. Or best of all if you want to take a leave of absence from work, save for this too!

Last but not least, how do you save?

The first step would be to choose accounts where you can automatically debit when your pay comes in and transfer the $ into savings accounts. Better yet would be savings accounts with no service fees and where you can divide into different folders (tax, travel etc).

In Canada you can also put up to $5000 a year in a TFSA (Tax-Free Savings Account). It works for many types of investments. It is the best option for long term non-RRSP savings. This is not a good option for your emergency savings. And like other investments watch the fees!

Another option is to automatically move long term savings into investment options. One of the most simple options is the Couch Potato investment plan. The concept is very simple. The idea is that the market does better than most any other investment strategy in the long run. So choose low cost investment options that mimic the market. Read more about it here.

I currently use mutual funds that are very low in management fees. Eventually when I have more money to invest I will move to self directed brokerage investments. But my savings are so low right now it doesn't justify the $50 a year brokerage charge.

Does it work? We got our RRSPs and RESPs 6 months after the market crashed. And the value of both has gone up at a very impressive rate. But you need to be patient and use this method for long term investment. Don't check it obsessively. And follow the plan!