Practical Advice to Achieve
your Saving and Investing Goals
If you're looking to build up your savings to create a cushion for you and your family today and into the future, investing wisely is one of the best ways to help get you there. That's why it's so important to think about saving and investing within the bigger context of your overall financial goals. Whether your goals are short term like a wedding or a down payment, or longer term like your child's education, a vacation home or retirement, developing a sound savings plan and investment strategy is a key step to reaching them.
Identifying your goals is critical to developing a saving or investment strategy. If you haven't established a clear goal, there will be a lot of unanswered questions–how much to save, what types of investments to choose and when you need to have the money. Being specific about your goals will help you to answer these questions and develop the right strategies for your situation.
Before you can consider investing, you have to set aside some money. Most people find this easier to do when they identify a specific amount that can be set aside on a regular schedule; for example, earmarking 10% of each paycheque to go into a savings account or TFSA. Once you start to accumulate some money, you'll need to decide how to invest those funds–your goals and your time horizon will help to determine the right strategy for you. But for now, let's look at some simple steps to help you build your savings.
- Finding the money to save.
How do you determine how much you can afford to save? Some people start by setting a specific savings target and make that a priority before looking at other needs or wants. Others start by taking a hard look at their spending patterns to see where they can cut spending. Click here to use our cash-flow worksheet to help you choose your approach. While either way can be effective, make sure that you set a reasonable target that allows you to cover your planned expenses without going into debt. And, if you have outstanding credit card debt, it makes sense to tackle that first before building up savings.
- Consider an automatic savings program.
Once you've determined how much you're going to save, set up a plan to automatically deposit those savings into an RRSP, TFSA or an employer-sponsored program. The best part about arranging for this contribution to happen automatically is you don't have to remember to transfer funds each time. You're also not tempted to divert the money for a last-minute purchase "just this one time."
- Start early.
The earlier you start to save, the harder your money works for you, because of the power of compounding returns.
Maureen and Marla are both age 65 with $500,000 in retirement savings. They both used the same investment funds, with an average rate of return of 4%. But Maureen's contributions over the years totalled $360,000, while Marla only contributed $216,000. How could this be?
The power of compounding returns! Marla started contributing $500 per month when she turned 29, while Maureen waited until she was 53 to start saving. Maureen had to contribute $2,500 per month to end up with the same amount as Marla.
- Where should I save first—TFSA or RRSP?
This question comes up often and the answer depends on the purpose of your savings and your current tax position. If your goal is fairly short term, the TFSA is an ideal way to save. However, if you want to save for retirement, you could choose either one. Here's a good rule of thumb: If you expect to be in a lower tax bracket when you withdraw the funds, the RRSP is the better choice. If your tax bracket in retirement is going to be the same or higher than it is today, opt for the TFSA.
- Take advantage of employer plans.
Some employers offer group savings plans where they match a certain portion of each employee's contributions. Others offer opportunities for automatic savings via payroll deduction, such as the purchase of Canada Savings Bonds. Not only do these programs make saving more automatic, and therefore easier for you, there is also the benefit of getting the employer's contribution when that is available. Look into what your employer offers and make sure to take advantage of it.
Once you've started to accumulate some savings, you'll need to decide how you want those savings to be invested. There are many factors that come into play here–your goals, your comfort with risk, your time horizon, and your understanding of different investments and how they work. Some may start off with very safe, secure investments such as guaranteed investment certificates (GICs) and term deposits that pay a guaranteed rate of return. These are ideal for short-term goals such as a down payment on a house, a vehicle purchase or an upcoming wedding. However, if you're looking for long-term growth, consider expanding your horizons to include individual stocks or mutual funds and exchange traded funds (ETFs) that invest in the stock market. Your financial planner* can help you to clarify your goals and recommend appropriate investments to meet them.
Important factors to consider:
Just because your friends or neighbours did well with a particular investment doesn't mean it's the right choice for you. There are lots of things to consider before you make the decision to invest. Here are a few factors your financial planner will ask you to think about:
- Risk tolerance.
How would you feel if your chosen investment dropped in value by 20%? Of course, no-one likes to lose money in the stock market, but the reality is that stocks go up and down in response to many factors, including economic conditions, market trends and company performance. As long as you don't need the money in the near future, you have time to recover from any losses and benefit from the long-term growth that equities can provide. But, for some people, that's easier said than done. If you think you might panic and sell your holdings when their value drops, it may be better to limit your exposure to the stock market.
- Time horizon.
If you're saving and investing for a short-term goal (within the next five years), you may not have time to recover from potential losses in the stock market. Regardless of how comfortable you are with the idea of your investments suffering a temporary decline, you may be better off not to run that risk. Fixed income investments such as bonds and GICs give you greater assurance that the money will be available when you need it.
- Asset mix.
Your total portfolio will likely be composed of a mix of types of assets, including cash, fixed income and equities. These types of assets fulfill different functions: cash for short-term income needs or buying opportunities, fixed income for stability, and equities for long-term growth. The percentage of each asset category that you hold depends on your overall goals and objectives as well as your time horizon and risk tolerance. Your financial planner will work with you to develop an appropriate asset mix for your situation.
Remember the old saying about not putting all your eggs in one basket? You can reduce risk by investing in a variety of securities rather than just one or two. For example, it wouldn't be wise to buy just one stock for the equity portion of your portfolio. However, a mutual fund or exchange traded fund (ETF) contains the stocks of many different companies and provides a level of automatic diversification.
As the saying goes, the best time to invest was yesterday; the second best time is today. Be less concerned about timing the market and concentrate on the most important factor—time in the market. Plus, if you're buying mutual funds, you can also benefit from dollar cost averaging. Contributing the same amount each month means that you buy more units of the fund when the cost is lower, reducing the average price per unit you pay over the long term.
Accumulating savings and investing well can be a challenging process on your own. A financial planner can help you determine the asset mix that fits best with your needs today and in the future. He or she will help you balance your goals, time horizon and your comfort level with risk.
Let's talk. Call a BMO Financial Planner today at1-888-389-8030
* BMO financial planner refers to Financial Planners, Investment and Retirement Planning that are representatives of BMO Investments Inc., a financial services firm and separate entity from Bank of Montreal.