Where to Start Saving First

by | Nov 6, 2018

The following article is an excerpt from our ebook “Women & Money”. You’ll note some gender-specific language here, but don’t let that deter you. Our advice is the same regardless of the chromosomes you carry. You can download the entire book for free here.

Let’s assume you’ve negotiated an outstanding salary. You’ve reviewed your income and expenses, and determined where you can free up some cash. You’ve started to pay down your debt in a strategic way. You’ve got a few bucks left to start building your future. Where should they go?

Savings and investments can often fall into three categories:

  1. Emergency Savings
  2. Short Term Savings
  3. Long Term Savings

Emergency Savings

This is the “if everything goes terribly wrong” pot of money, and it’s the first one you need to build. If you’re okay with a little foul language, check out The Story of a F*** Off Fund.

The standard rule around emergency savings is to have 3 months’ expenses in the pot, but where did that idea come from? Why 3 months?

Many financial issues can be fixed in about 3 months:

  • If you’ve lost your job but are pretty employable in an economy that is producing work, a 3-month window to get you on to a new “horse” makes sense.
  • If you have disability insurance through your employer that has a 3 month waiting period (sometimes called an “elimination period”).

You may need more than 3 months’ expenses if you:

  • Are self-employed. If you run your own business or consult/contract, then it may take more than 3 months to pull yourself out of a downturn in business. You may not have access to Employment Insurance or disability insurance. Both are available to self-employed individuals, so you should look into this as well.
  • Don’t have access to disability insurance through your employer or through a private plan.
  • Work in an industry that is vulnerable to a recession, and obtaining a new job may take longer than 3 months.

Your emergency savings should be easily accessible. Emergencies are usually unexpected and sudden. You may not be able to wait 3-5 business days to get your hands on it.

As these funds are something you need to be able to rely on and access at any time, the vehicles you invest in should be low-risk and guaranteed. That first month’s expenses should be in a high-interest savings account that you can access from an ATM. The rest can be in short-term investments that take a few days to access, such as money market funds or cashable GICs/Term Deposits. You won’t earn a lot on this money, especially with interest rates being as low as they are, but you won’t lose any money either. That’s the biggest key for Emergency Savings.

Short Term Savings

Short-term savings are for reaching specific goals. It could be that you want to buy a condo, a car, or go on a vacation. It’s any kind of savings where you’ll be accessing that cash in 5 years or less.

Let’s walk through another example.

Anna wants to buy a condo in 5 years. She’s targeted a down payment of $50,000. She’s never deposited to a TFSA before, so as of 2016, she has $41,500 in contribution room, which will grow by $5,500 every year. She’s not going to exceed her contribution limit within those 5 years, based on her goal.

Anna found an investment that will guarantee her 2% a year throughout the next 5 years. Using a future value calculator, she determines that with 2%, she can reach her $50,000 goal in 5 years by making payments of $9,450 per year, or $787.50 per month.

A higher rate of return would definitely allow her to reduce her monthly savings. But with higher returns comes higher risk. Since Anna is committed to reaching that goal within 5 years, she’d prefer not to take any risk with her contributions and therefore has accepted a lower return rate than she might earn by putting her money into a riskier investment.

Long Term Savings

You may be surprised to know that the females of our species actually have some advantages when it comes to long term investing:

  • Women live an average of 3 years longer than men. This gives women more time to weather the inevitable ups and downs of the market. This is known as a having a longer investment horizon.
  • Women are more likely to follow professional advice, and tend to be more patient with market fluctuations.
  • Women tend to trade less frequently than men do, which decreases investing costs and reduces the opportunity to make poor decisions on impulse.

An important note about ‘risk’

To many women, the word ‘risk’ has an inherently negative connotation that many men simply don’t share. There’s a whole bunch of psychology behind why this is the case, but it’s important to try and think of the word in the specific context of investing.

Would women be more likely to invest if we used the word ‘chance’ instead of ‘risk’? Maybe. Many women discover that, once we learn about what risk actually entails, we’re not as conservative as we might have thought. For example, how many women do you know who have started a business? Between 2001 and 2011, the number of self-employed women in Canada grew by 23% (compared with 14% growth in male self-employment). In many ways, entrepreneurship is incredibly risky – and yet, women are taking the plunge for the opportunity of higher earnings and greater control over their careers.

In finance, ‘risk’ is simply the lack of a guarantee – positive or negative. In order for an investment to go up (or down), some risk must be involved. So while risk does mean there is a chance of loss, it also represents an opportunity for gain.

Stuffing your money in your mattress is risk-free. It guarantees you won’t suffer market losses, but it also guarantees your money won’t grow.

In short, risk isn’t something to be avoided at all costs, it is something to be managed, within reason, in a way that you are comfortable with. Also, the risk involved in investing isn’t the only kind of financial risk we face. So while it’s important to be aware of investment risk, there are some other important risks that we need to keep in mind, specifically:

  • Outliving our money (aka ‘longevity risk’)
  • Paying too much in fees. We don’t want to pick on mutual funds too much, but on average, they tend to have higher fees than many people realize. But because you usually don’t pay them out of pocket, it’s tough to know exactly how much you’re paying. If someone offered you two similar investments, with one earning 2% more than the other, which would you choose? Most likely you’d choose the one earning the extra 2%. And yet, we often pay this much in fees without thinking about what we’re giving up over the long term. The Canadian Centre for Policy Alternatives reports:

“If the higher fees on mutual funds (2.1%) seem small, we must remember that compound interest can work against an investor as easily as it helps them. Over a lifetime of contributions, the average mutual fund investor will have to work until age 72 to accumulate the same amount as the pension plan holder had by age 65 due to this seemingly small fee difference. ”

  • Inflation risk. This is a big reason why you don’t want to just keep all of your money in a chequing account. Over time, the purchasing power of your money decreases. $20 today isn’t the same as it was 10 years ago or what it will be 10 years from now. If your money isn’t growing, it’s shrinking.

So what exactly should you do with your money? For emergency and short-term savings, it’s important to keep funds in relatively conservative investments, because you may need to access them on short notice. Long-term savings are a different beast entirely. Assuming you have a few years yet before you plan to retire, you may be able to take a more aggressive approach with your long-term savings than with your emergency and short-term savings.

Both Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) can be great options for long-term savings. Both can contain term deposits, GICs, cash, mutual funds, exchange traded funds, publicly-traded stocks, etc. Contributions to your RRSP are deducted from your taxable income, decreasing the amount of tax you pay. When you make withdrawals later on, presumably in a lower tax bracket, you’ll pay less tax than you would have earlier on.

With TFSAs, you don’t get a tax deduction for making a deposit, but you also don’t get dinged with tax when you pull the money out. While the funds are in there, earning money, you don’t get taxed on those earnings.

Things to do right now to get your savings in shape:

  • Make sure at least 1 month’s expenses are available to you at midnight on a statutory holiday. An additional 2 months’ should be accessible within a week’s notice.
  • If you currently hold mutual funds, try this Fee Analyzer to find out how much of your investment is being eaten up by fees.
  • Consider finding your own financial advisor, even if you already share one with your spouse. Our friend John at Holy Potato has a list of fee-for-service advisors (i.e. advisors who charge a flat fee for advice and instead of earning commissions for selling certain products).
  • Build your investing confidence without risking your money – set up a trial account with an online investment manager like ModernAdvisor.
  • If you want to learn about buying and selling individual securities, many discount brokerages also offer practice accounts where you can trade with pretend money.

Want more great tips? Remember to download our free ebook, Women & Money, here.

This article is brought to you by Spring Planning Inc. for informational purposes only and does not constitute financial, tax, or legal advice. This information is furnished on the basis that Spring Planning Inc. is to be under no liability whatsoever in respect thereof. It is provided as a general source of information and should not be construed as an offer or solicitation for the sale or purchase of any product or service, and should not be considered tax or legal advice.