Why are you saving your money?
What is the point of saving money?
Or in other words, why don’t you just spend all the money you make, as you make it? You’re gonna make more, right? So shouldn’t you just spend your full paycheque and assume that paycheque will always exist, and that you’ll be able to work until the day you die?
For most people, there is one basic assumption for saving money: they make more money than they spend. If you spend more money than you make, you have no money to save.(If you don’t have any money left over, or have negative money, then this post is probably not for you, but please check out my post called “Maybe you spend too much on candles…”)
If we assume that assumption is correct, then we can look at the reasons that we choose to not buy a bunch of things we don’t need, with the extra money we have left over.
Well, not everyone saves the extra money they have, like this guy who is 31, makes $130,000 per year and spends it all on extravagant things. He eats out all the time, takes really expensive trips on a moment’s notice etc. Money is no object, because he makes so much, but his bank account is empty.
But I’m not like that guy and likely you aren’t either.
IT’S CALLED BALANCE
I’m interested in enjoying life now, as everyone should be, but I would also love to have the freedom to stop working(or work less) in the future because I’ve saved enough that I can make less working because my investments are making money for me.
It’s called balance. Meeting somewhere in the middle between flying to Las Vegas on a whim and eating a $200 steak, and eating Kraft Dinner at home with the heat off to save money on electricity.
I’m also aware of potential change of circumstance, health, economy, ability, and that nothing in life is guaranteed. So to live my life without any kind of safety net(even a short-term net) seems a bit reckless.
So here are my two main reasons for saving:
- Emergency Cash(aka, the “FU fund”): I think it’s important to have at least 6 months of living expenses in an emergency fund in cash so that if you leave your job or if something happens, you have time to make a new life plan without worrying about how to pay rent. I started this fund a while ago and I am proud to say that it is now fully funded. I could quit my job and take 6 months to look for another one, if I wanted, without having to change my current lifestyle. I recommend it to everyone. It feels great.
- Retirement Fund: I would like to have the freedom to stop working at the age of 65 when my CPP and OAS kick in(or earlier if possible) and live comfortably for 30 more years with the money I have saved. (I answered all the questions on this site and it said I’m living to 90. So I added 5 years to be safe.)
Since my emergency fund is good to go, I only have to worry about my retirement fund. Without using specific dollar figures, here’s the calculation:
- Goal: save enough each month from the age of 35–65 to build a fund that pays for my current living expenses for 30 years from 65–95
- Rate of Return before retirement(over 30 years): 5%
- Rate of Return after retirement(another 30 years): 4%
- Average Inflation over 60 years(per year): 2%
The result?
I still have extra money left over at the end of each month after saving for retirement!
Note: The retirement age of 65 is really important in this example. The reason I don’t have to put the extra money in my retirement fund is because when I turn 65 I will get CPP and OAS payments from the government. In my example, that’s 50% of my living expenses paid for by the government. That’s a lot. If I decide to retire at 64, for example, my money runs out when I’m 91–4 years earlier!
SO WHAT DO I DO WITH THE EXTRA MONEY??
If you’re lucky enough to be in this situation, you don’t want to mess it up.
Do I spend it all like the 31-year old guy? After all, I’m setup for retirement at 65, right?
Wait, before I spend it, let’s think more about the next 30 years.
How much do I really know about what’s going to happen between now and 65?
Maybe I want a house. So I should save for a down payment, right?
Maybe I’ll have a kid, or 2, or 3. I should start building up a fund for the kids then?
The point is, I don’t know right now. And that’s what makes saving vs. spending so difficult.
It’s hard to see the future.
Really hard.
Like, you actually can’t see it.
No one can.
Except maybe this lady:
If a house and kids…
or making less money…
or moving away…
or taking a year off…
or anything different from your current life situation…
is a possibility…
then you probably shouldn’t spend the extra money.
If you are:
- Comfortable with your everyday spending
- Have your emergency fund good to go
- Are saving enough for the long-term, according to your retirement goals
…then you don’t need to save any more, but you also don’t need to spend any more.
SO WHAT DO I DO WITH IT ALREADY?!?!?!
Well, don’t lock it away in an RRSP, as you want to be able to change your mind next year.
And don’t invest it in anything that may be subject to risk in the short-term for that same reason.
My advice would be to keep it in a high-interest savings account and revisit your goals every year.
Maybe in 5 years you will decide you want a house and abracadabra, you have a nice down-payment sitting there in cash ready to go.
Or there is a baby on the way in 3 years and you don’t have to worry because you’ll have a bunch of cash saved up to cover the extra cost that is children. And don’t forget that’s on top of the emergency fund you already have.
It’s even ok to set some of it aside to spend. No, really. Go on that trip, or buy that new TV you want. You can do this because you already took care of the retirement planning and you know that this is really extra money for you.
Another option is that you don’t trust inflation or interest rates, so you take some of the money and add a bit more to your RRSP or TFSA contribution. You’ll feel better about your retirement without having to use too much of your potential future house and baby money.
What did I decide to do, you ask?
I took 40% of it and added it to my TFSA. I still have a bunch of room in there and I should be maxing it out because TFSAs are awesome(more about that in a future post). But that’s just the decision for this year and I may change my mind next year. It’s ok, because this is just money that’s not earmarked for anything yet.(And I can always withdraw it from my TFSA without penalty, and get the room back the next year.)
I’M ON THE RIGHT TRACK
That’s really the point here. This is why we do a financial plan and don’t just decide to throw all the extra money into the RRSP automatically. Remember the balance — somewhere between saving all your money and saving none of it.
I can’t just set everything in motion and check back when I’m 65 and start raking it in.
An annual review of my situation will tell me if I need to move things around based on a change in circumstance.
But for now, I’m gonna put away the amount determined by my calculations and save the rest for future Beau. And if I want to go on a trip, I’ll go on a trip, because I know I’m investing the rest of my money wisely.
