5-Step Guide for Financial Liftoff
I just finished watching an episode from the show Modern Love.
In it, Dev Patel — who received an Emmy nomination for this episode — plays founder of a dating app. His character explains his philosophy on relationships like this:
I have this theory that a relationship is kind of like a rocket, and you’re trying to get it into space. And all you need is enough fuel to get you out of Earth’s atmosphere, and then it will keep going, no matter what you throw at it, in the, in the direction it was launched.
Take a second. Agree or disagree in your head. And then let’s move past it because this is about *finance*.
Now, if you go back to the quote and replace the word “relationship” with “wealth”, it then becomes less of a theory and more of a conventional wisdom. The early earning years are crucial to the wealth building process.
The following basic financial planning steps should be taught at a high school level. But for whatever reason, they’re not. So if you or a someone in your life is looking for structured advice, here’s a simple 5-step guide.
(If one of the steps doesn’t apply, just skip it.)
Maximize RRSP matching from employer
Most Canadian employers offer some RRSP matching. It could be 50% matching on the first 3%. It could be a 100% match on the first 6%. Whatever it is, opt in for the maximum employer contribution. It’s free money. It’s part of your salary. And it’s effectively like getting a 50%-100% return on your investment.
Pay off any high-interest debt
High interest debt will dangerously chip away at your wealth. Get rid of it ASAP.
- Credit cards! Commonly charging up to a 24% interest rate (or, APR), can be costly if not paid off promptly. Set up auto payments through online banking in the amount of the balance to eliminate this debt ASAP.
- What about student loans? The Canadian federal student loan rate is prime plus 2.50%. As of March 2021, the prime rate is 2.45%. So student loans cost 4.95%. Okay, so maybe not high interest, but not low either. I would try to accelerate paying these off too.
Create an emergency fund
Also known as a rainy day fund. This is money set aside in a checking or savings account that you can access should life surprise you with unexpected expenses, or a loss of income. This should be at least 3-6 months of salary.
(Once you get this far, you can start investing!)
Maximize contributions to TFSA
A Tax-Free Savings Account allows the investments you hold inside it to grow tax free. The value of your stocks/ETFs go up? No tax. You’re paid a dividend? No tax. You’re paid interest on a bond? No tax. Forever.
You can also withdraw funds any time you would like, and re-contribute that amount next year again.
How much can you contribute to a TFSA? It just depends on only two things: your age, and whether you were a Canadian resident.
Here’s a quick tool I’ve created to calculate your TFSA room.
TFSA Room Calculator
What year were you born? Which years were you a Canadian resident?
Here is the Gov’t of Canada page with the nitty gritty details on TFSAs.
Maximize contributions to RRSP
The RRSP is another account which allows the investments inside it to grow tax-free. It’s meant to be used for income during your retirement.
The amount you contribute to your RRSP account in any year is reduced from your taxable income. So you’re paying less income tax by contributing to an RRSP. However, unlike a TFSA, everything you withdraw out of an RRSP account is taxed as income (which in most cases, will happen during retirement).
How much can you contribute to an RRSP annually? The lower of either: 18% of your income OR $27,000. And any remaining contribution room keeps carrying over to future years.
Here is the Gov’t of Canada page with the nitty gritty details on RRSPs.
TFSA and RRSP maxed? Okay, now you can start using advanced wealth management strategies. Time for liftoff 🚀