There are a number of things you can do to become financially responsible, such as having an emergency fund for unexpected expenses. While that’s common sense, there are some other personal rules that will help keep you on a strong financial footing.
Here are five rules to live by:
Don’t spend more than you make
While this rule sounds like it should be obvious, a lot of people still get into financial trouble because they overspend. And it can lead to bankruptcy for many consumers. There were 125,266 Canadians who filed for bankruptcy or a consumer proposal (an offer to pay creditors a percentage of what’s owed to them) in 2018, according to Statistics Canada.
One great way to ensure you don’t spend more than you earn is to have a budget. By tracking your spending, you’ll be able to see what you’re spending your money on. Try it for a month and track every penny. It will be both annoying and enlightening at the same time.
Pay off your credit card balance in full every month
Credit cards are both good and bad. Rewards credit cards, for example, are a great way to earn points or cash back. However, they’re not worth it if you don’t pay off your balance in full and on time every month. Carrying a balance isn’t great, especially if the interest rate is 9.9%, 19.9%, or even 29.9%.
If you have a balance of $3,000, the interest rate is 19.9%, and you make a payment of $200 a month, it will take you 33 months to pay it off. You will also have to pay $1,511.27 in interest or $6,1511.27 in total. That’s assuming you don’t make any additional charges to the card.
An alternative is to get a line of credit or a balance transfer credit card. The rate on a line of credit will be much lower, depending on your credit score. A balance transfer card will usually have a transfer fee (2% to 3%) and no interest for a certain period of time. In an ideal world, you’ll pay off the balance in full before you need to start paying interest.
If you do get a line of credit or balance transfer card, the secret is not to run up the balance on your old card again. If you do, your debt will increase and you’ll be worse off than before.
Save 10% to 20% of your income for retirement
A car, a home, children. These are usually the things you think about saving for before you even think about saving for retirement. While it may be decades away, there’s no time like the present to begin saving.
If you’re in your early 20s, 10% of your pre-tax salary is a good number to start with. If you wait until your late 30s, you’re going to need to save 15% to 20%. Saving a high percentage right off the bat may be difficult and you will be more likely to fail, just like if you try to diet and immediately cut your sugar and junk food intake down to nothing. Instead, start with saving something like 3% or 4% and increase that every month until you reach your desired amount.
The best way to save is to do it automatically. Set up a weekly, biweekly, or monthly pre-authorized contribution so you won’t be tempted to spend the money sitting in your bank account.
If you have short term investment goals, be sure to take advantage of a Tax-Free Savings Account or a High-Interest Savings Accounts, which are both suitable options for saving up for short-term goals. Using a HISA can be a great way to grow your savings quicker. However, interest accrued on those savings might be subject to taxation.
Buy low-cost investments
There are so many investment options: mutual funds, stocks, bonds, GICs, exchange-traded funds (ETFs), and robo-advisors, just to name a few. But there are usually costs associated with each, which can affect your overall return.
An ETF is a type of fund listed on a stock exchange that holds a basket of stocks or bonds or both. It usually tracks an index and does very little trading, which results in a low management expense ratio (MER)—the annual fee charged to investors to cover the cost of running the fund. This fee can be as little as 0.03%, but they usually average around 0.2%.
While you usually have to pay to trade ETFs, there are some discount brokers (such as Questrade or Scotia iTrade) that don’t charge a commission to buy some ETFs. If you invest $10,000 in an ETF with an MER of 0.2% and the annual rate of return is 7%, you will end up with $51,624.75 after 25 years.
Robo-advisors manage your money for you, rebalance your portfolio, and are low cost because they invest in ETFs. However, they do charge a management fee of around 0.5%. Combined with the cost of ETFs, the annual fee will average around 0.7%. If you invest $10,000 with a robo-advisor that charges 0.7% and the annual rate of return is 7%, you will have $45,532.94 after 25 years.
Mutual funds also manage your money for you, but they can be the most expensive investment of all because of all the trading they do. Canada has the highest fees in the world, according to research firm Morningstar. If you invest $10,000 in a fund with an MER of 2% and the annual rate of return is 7%, you’ll end up with $32,752.64 in 25 years.
Even though 2% doesn’t sound like a lot, high fees can have a negative impact on your overall return. Choosing a low-cost option will give you more money over the long run.
Take advantage of workplace savings plans and tax-sheltered accounts
Many companies offer group savings plans with a company match. This amount varies based on your employer’s generosity. For example, if you contribute 4% of your salary to a group RRSP, your company may match all of that amount. That’s equivalent to an 8% contribution, half of which is free money.
Speaking of RRSPs, they’re a type of tax-sheltered account. Holding your investments in one means any investment gains aren’t taxed until you start making withdrawals (except for the Home Buyers’ Plan or Lifelong Learning Plan). There’s an even better tax-sheltered account called a TFSA. Again, your investment gains aren’t taxed. However, your withdrawals don’t count as income, meaning you don’t have to pay tax on them.
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