Updated: Sep 17, 2021
Saving should be a relatively simple process, and depending on your desire to reach your goals quicker, like buying a first home or retiring earlier, will always involve some degree of sacrifice. Your ability to do some basic math will help you enormously in life, and if you can draft up a simple spreadsheet with some compounding formulas, you will be able to ink out a timeline with some values to help you visualize your goals. This can be a powerful tool for making your plan visible to you, and it further enables you to make adjustments as necessary. It will ultimately motivate you to achieve your goals. The following spreadsheet, which I built in a few minutes, shows a household income of $90,000 with a modest annual savings rate of 15%, which is very achievable. It assumes a total average return of 6% a year, assumes a 4% dividend and 2% share growth per annum, and no tax. This is also achievable, providing you buy a quality, global index-tracking ETF, and drip your dividends back into your RRSP/TFSA accounts throughout the year and over time. I personally like Vanguard ETFs for their low fees, quality products, and great management, but there are other decent discount providers out there.
This is a very simple spreadsheet, and it assumes you maintain the same discipline year after year and do not pay taxes on your gains. TFSAs and RRSPs allow you to avoid taxation, and both have their own unique qualities. Please read the BLOG “The Govt’s Gift To You; RRSPs and TFSAs”. This spreadsheet takes your year 1 starting point of $13,500 in savings and adds the 6% total growth back into the starting principle, which creates the starting point in year 2. The formula is repeated year after year, and shows you the power of compounding growth in your savings and investments. The compounding effect is a combination of your annual savings rate, the dividend (or interest) rate, and the share price growth being applied over and over. You can see how quickly you can save towards a first home downpayment of 5% in ~3-5 years, or 1 million dollars in ~30 years, using this approach and these hypothetical numbers. If you are a double income family earning $50,000-$80,000 a year, then the miracle of compounding works exponentially for you!! For example, if your household net income is $160,000 per year and you can save 50%, you can achieve a million dollars in savings using this formula in just 10 years, and 2 million dollars in 16 years!
When you visualize the process of savings and investing, and set goals to achieve them, they start to present other possibilties to you. You start to ask yourself, “how can I save more?”, or “how can I increase my take-home pay?”. You will start to look deeper into your household expenses and/or your ability to progress or upgrade both your career and your earning power. You will start to ask yourself, ”what do we really need to be happy in life”, and you may start to avoid impulse purchases that prevent you from reaching your goals. You may buy an affordable, good, used car in your first year of work and drive it for 10 years, to avoid hefty bank loans and the associated interest payments eroding your savings and changing your goals’ trajectory. You may delay starting a family for 5-10 years, get that house, and/or build that nest-egg quicker. It becomes a question of “what am I willing to do to achieve my goals faster?”.
If you are saving towards a near term goal where you need the money, like a first home, then you should probably put it into a TFSA first. I would maximize your TFSA room, then consider RRSPs. TFSAs allow easy access to funds and can grow and be withdrawn completely tax-free, while RRSPs also grow tax-free, reduce your income tax in the year they are purchased, but are taxed at your marginal tax rate upon withdrawal. TFSAs also allow you to contribute up to your lifetime allowance any time, and if you take money out you can put back what you took out up to your lifetime allowance. I would suggest every Canadian build a plan to maximize these programs, with a focus on utilizing the full power of your TFSA room first. If you can maximize both programs it is the best case scenario, but this is not achievable for a lot of Canadians.
One other thing to note, is the first spreadsheet assumes you make the inputs of savings and growth one-time annually. If you have set up your savings and DRIP (dividend reinvestment plan) to occur monthly, you will see further growth as your money goes to work faster (monthly) creating more dividends and growth. Your financial institution should be able to help you set this up so it’s automated. If you contribute your savings and reinvest your dividends on a monthly basis using the same numbers for income and returns, you will realize an additional 3% increase in your savings yearly. This creates a larger snowball affect, allowing you to reach your goals in even less time. You will also see greater benefit from averaging more frequently into your investments. This means you will buy in and achieve an average share price over time, which makes it a lot less likely you will lose value when you want or need to withdraw the money. The spreadsheet below compares a double income family with combined net income of $160k, a savings rate of 50%, and a monthly DRIP plan (on right) against the annual DRIP plan (on left). If you look at year 1 and year 2 totals on the monthly plan on the right, and compare it to the annual year 1 and year 2 totals on the left, you can see the differences in the values between a yearly plan and a monthly plan.
These spreadsheets are fairly simple, assume all things remain the same, and uses some assumed average returns. We all know that there are factors over time that will impact these numbers and this is not a linear journey. You may need to change the savings rates for various reasons (job loss, unexpected financial hits, etc). The share prices will fluctuate over time changing the account value/s, and you will eventually need to weather a stock market crash, or as I like to call it, “A BUYING OPPORTUNITY,… OR TIME TO DOUBLE DOWN!!”. There could also be dividend cuts, but more likely and more often there will be increases if you are in quality index-tracking ETFs!! At the end of the day, you need to prepare yourself mentally for the ups and downs of your plans, so you will be able to avoid common mistakes. Keeping it simple! Creating a visualization and a plan that is automatized will help you get there!