Introduction to Saving and Investing

Saving and investing is easily the most popular topic in personal finance, especially investing. There are literally thousands of opinions and strategies out there regarding investing, and it’s no doubt important to be able to sift through it all and understand it in order to make the correct allocation decisions for your portfolio. But what most people forget is that the key to building wealth is saving, not investing.

The best piece of advice regarding saving? Spend less than you earn.

How important is saving? I couldn’t possibly overstate its importance, especially in today’s day and age. There’s not much more to say about it. You need to save. Well, you might ask, isn’t it a bit early to start thinking about retirement? While I do think it’s never too early to think about retirement, plenty of financial advisors would agree with you. Regardless, what I would recommend is that you have to have a plan and set some goals, even if they may be meagre. The worst way to approach your financial wealth situation is just earn income and spend it, in a kind of aimless way. So many couples have done that for the first 15-20 years of their marriage, only to wake up in their mid-40’s and find out that their dream retirement lifestyle may not be attainable. You need to have some sort of plan and set goals around that plan.

So you’re ready to set some goals, eh? But where do you start? You first have to understand your current financial situation in its entirety. How can you make a decision about your financial future if you don’t know what’s presently happening? First of all, you must know the extent of your assets. How much money do you have in the bank? What’s the total amount of assets you own? Next, what’s the total amount of liabilities that you have? As well, for each liability, what interest rate are you paying on that debt?

Assuming you know your current monthly income, how are you spending that income? In order to save, you need to know your current expenditures. I have attached an excel file which breaks down an average family’s expenses and provides a really simple way of tracking your own expenditures.
https://docs.google.com/fileview?id=0B7Pb2iJ73yaOMzcwZmEwYTgtNTBhNy00MjA5LThmMjEtNzgzNzNhYWIzNDA3&hl=en
(Press "Download" on upper left corner)
Note that the numbers I chose on the file are completely random (based on a $50,000/year income); you can fill in your own. Let me break it down for you:

Line 5 – enter your total monthly income.
Lines 8-14 – these are your fixed expenses that generally stay the same each month. Notice that I have a ‘savings’ account for line 14 – I’ll talk about this later.
All lines after that are your variable expenses that change on a monthly basis. You can write a quick description of what the expense is (as I have) and then the expense amount.
You can add in as many lines as you like (my chart has more than 50 lines – Microsoft Excel gives you 32,000 lines, so you should be ok), or subtract them if needed. As well, certain expenses are paid once a year but can be spread out for the whole year. For example, a synagogue membership or insurance payment is often made once a year. However you can divide the total payment by 12 and enter it as a monthly fixed expense (otherwise known as accrual accounting).

Line 3 automatically subtracts the sum of all your expenses from your monthly income to get your final balance for the month. You can update this excel file once a month. Assuming that you mostly pay everything with a debit and/or credit card, you can simply log onto your account online, see your expense, and copy them over one by one. If you spend a lot of cash, it may be tougher to keep this file, but try your best. Spending 10 minutes a month updating this excel file will keep you in touch with the money you are spending.

A word for the wise: Don’t be too specific about your expenses. For example, if you recently spent $100 at Metro, don’t break it down by the margarine, breads, etc. This will drive your spouse insane. A general number is good enough. Just put $100 down and write “metro” next to it.
I honestly think that the exercises shown above are the most important steps to building a stable financial situation for your future. All the other stuff concerning investments, mortgages, RRSP’s, etc. are important, but if you aren’t keeping track of your financial situation at least a few times a year, then those investments won’t get you anywhere. These exercises also give you the tools needed to begin saving. Even if you don’t have a grand financial goal, or have yet to determine an appropriate monthly savings amount, at least just start with a really meagre goal – perhaps $100/month. Put that amount in as an expense – the best way to save is to take it off the top, rather than waiting for your ending balance to determine your monthly savings (line 14 on the excel chart!). Any positive amount left on your monthly balance can be an added bonus to your savings, or you can use that as a treat – maybe go out to a nice restaurant, or save that for a vacation.

The obvious question that I haven’t addressed is: How much do you actually have to save on a monthly or annual basis? You ask that question to any financial advisor in the world, and they’ll look right back at you and ask, “What are you saving for?” In other words, what are your lifestyle goals, both in the short-term and long-term?
Your answer can include buying a house, sending my children to private school, taking an annual vacation to Europe, buying all my clothes at Holt Renfrew, etc. Your lifestyle goals will determine your savings needs.

Most young couples are probably worried about: How much money do I need to buy a starter home? I will deal with this question in the future. The important thing is that you understand what it takes to begin creating a savings plan. Even if you are unsure of anything in particular, as I said before, at least just make a small savings goal (of $100/month are whatever you’re capable of) and keep track of your monthly expenses. These simple acts will go a long way to improving your financial situation both in the present and for the future.

Next week I’ll discuss portfolio allocation.