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A Small Measure

January 26, 2011

I’m currently debt-free. Well, that’s not completely true; I still have a few hundred dollars of credit card debt, but that will be gone next month. I’m also getting my monthly budget back under control, which is slow but promising. It’s taken a long time to get to this point. Several years, in fact. It’s been a fairly uphill battle.

There is always a group of people who will maintain that debt is your own damn fault, that you put yourself into that position, and you can just dig yourself back out on your own. Within a certain range…they’re right. For many of the trivial things I’ve purchased, I have nothing to show but receipts, interest rates, and debt. I didn’t need the instant gratification that comes with credit. I will concede to some of this.

But, outside of this range, there are other considerations. One of which has been euphemistically called ‘debt fatigue’. After an amount of time living with crushing personal debt loads (most finance experts set about 3 years as the average), people tend to give up on ever being debt-free. It’s usually around this point that the debt amount begins to spiral out of control, with bankruptcy slowly becoming the only real option.

Another is the extremely warped sense of competing priorities that financial institutions can lead you to believe you must all fulfill simultaneously. We are told that we need to save, that we need to invest, that we need to plan our insurance strategies, that we need to do a hundred different things, all at once, with the only over-riding strategy being the purchase of ever more complex financial instruments, many of which we don’t understand.

I’m not a financial planner, nor, given my recent five-figure debt figure, hardly an expert. I’m in the clear, for the first time in about 5 years, but I won’t have a dime in savings for several months yet, and it will take me several years to recover. I can’t tell you what mutual fund to invest in, or what the current GIC rate is.

Instead of sweating the big stuff, I’d like to work over some of the smaller things I’ve begun to learn as I inch my way back from the ledge.

The rule of 72

This is a fairly simple rule, hardly precise, but an incredibly good rule of thumb to memorize. Simply, you divide the annual interest rate you’re currently receiving into 72 to determine how many years it will take to double your money. For instance, 72 / 3 = 24, so it will take you 24 years to double your money at a 3% annual interest rate. My current TFSA account is close to 1.2%, so it would take 60 years to double my money (which would be good news to my grandchildren, if I had any).

Now, 24 years sounds like a big number, but if you’re still age 40 or under, you can still make out, and rates of 4-5% are challenging to get, but not impossible.

Fifty cents a day

Everyone should have a simple jar on their night stand, kitchen table, wherever you keep your personal stuff when it’s not in your pockets. At the end of the day (every day), throw your change into the jar. Pick a reasonable schedule to roll the change. Bring it into the bank and deposit it into your savings account or TFSA.

Almost everyone generates an average of about 50 cents a day in loose change. That’s $182.50 a year. Applying the rule of 72, and assuming a 3% annual interest rate, in 24 years you’ll have close to $6,842.30, but only $4,380 will have come from the jar. That’s a pretty hefty amount of interest.

Dismiss this as trivial if you must, but you’re going to generate that change no matter what you do. Would you rather have the $6,842.30, or the daily candy bar (or coffee, or whatever impulse buy would have been generated from that change in your pocket)?

This is the strategy behind the ‘pay yourself too’ plans currently being marketed by financial institutions (Scotiabank has one). They round the difference on any ATM store transaction up to the nearest dollar (if the merchant charges you $9.25, $10 is withdrawn from your account), and the extra (75 cents) is deposited into a savings account you open for this system. I don’t use these plans, as they encourage ATM use for everything, which increases the chances of having your card compromised, and exposes you to smaller merchants who must charge an ATM fee.

Whichever method you choose, your pocket change can dramatically alter your capacity to invest…if you save it.

Open a Tax-Free Savings Account

If you are eligible, there is no sane reason not to have a TFSA. Other than the contribution limit ($5,000 per year), there is no downside to having one. Many financial institutions will push you to have an RRSP, and there is every reason for having both. But there is no reason to prefer one to the other exclusively, and if you are (like myself), just bringing your finances back into line, a TFSA is a better choice for several reasons:

  • It is tax-free (free as in beer), where an RRSP is tax-deferred. You will eventually pay tax on your RRSP contributions, and there is no legal way around this. Everything inside a TFSA will never be taxed, ever. This is why the contribution limit is so low.
  • Unused contribution room isn’t lost. If you can only afford to add $1,000 for the next five years, the other $20,000 of unused room is carried forward, and can be filled in when you have the cash.
  • You can withdraw from a TFSA at any time, for any reason, without being taxed, making it an ideal solution for building an emergency fund, while keeping the money tax-sheltered. There are penalties for withdrawing from a TFSA, but if you are careful and work with a financial advisor, these amount to delays to adding the money back to the TFSA. I think this is reasonable.
  • A TFSA is simply a shelter for money, and can hold different investment vehicles. As long as you stay within the contribution limits, the money within a TFSA can be split between traditional bank accounts, GIC’s, CSB’s, and even mutual funds. So, if all you can currently afford is the change jar, you can still build up enough money over months or years to transfer from a low-interest savings account to a higher-interest GIC that stays within the tax shelter of the TFSA.

Gordon Pape has written several excellent introductions to the TFSA. I urge you to pick one up; they are quick reads that cover the gamut of investment decisions one will face at different ages.

The only thing under your mattress should be the floor

I’ve had a lot of interesting conversations with people who claim to have a lot of money in the house, in safes or ‘hidden safely away’. There are a few problems with this:

  • Houses are flammable. Thieves pick locks. You can’t claim insurance on cash tucked in a safe. When it’s gone, it’s gone.
  • Tax happens. You can only keep it hidden from Revenue Canada for so long, and the longer you hide it, the angrier they are when they find it. And they will find it.
  • Inflation happens. Even a savings account that only gives you 1.25% annual interest will help keep that money competitive with future living rates.

Subscribe when it doesn’t shaft you

There are lots of situations where you’re given a choice of multi-year payment plans that offer you lower monthly rates (cell phones are the obvious example).

Read the fine print. Cancellation fees, hidden provisions for rate hikes, etc, will kill any advantages the plan gives you. There are many online resources for finding out the real cost of a subscription service. Even messaging your BFF’s can get you valuable intel.

Walk to save

I am notorious for using the most convenient ATM available, even when walking a block will save me a service fee. This can cost me $10 a week (that’s over $500 a year).

This isn’t just about ATM use: take the bus, even when you want to indulge in the taxi. Use the supermarket, even if the corner store is closer (and more expensive). Wait until you are buying enough from an online retailer that they reduce shipping fees.

Instant gratification costs more money than the (often trivial) wait or delay.

A wise general always keeps something in reserve

Ahhh, Sun Tzu, you had me at “The Art of War”…

The last few severe financial emergencies I’ve had involved job loss (not surprisingly). The world of web development has had many highs and lows, and many agencies have fallen, despite the best efforts of their employees. In all of these emergencies, unfailingly, I’ve been caught with nothing to keep me going until EA has stepped in.

An emergency fund should be your top priority, before buying a house, car, or any other capital purchase. The fund should cover at least 1 month (minimum) of your current wages; 3 is better, 6 a dream. You never use this money for anything other than covering your ass. You don’t buy the house or car with it. You don’t invest it. You keep it for immediate use, when you absolutely have no other option but to spend it. Period.

Complimenting the emergency fund, you should also ‘disaster shop’. By this I mean, keeping a few months of necessities in the house at all times. During a job search, the last decision you should need to make is buying a bottle of shampoo versus having bus fare to go to the next interview. I’ve had to make these decisions. It is depressing, disheartening, and shaming. No one should have to make decisions like this, but many are forced to. You should also take bills you can pay in advance and give yourself a 2-month headwind. Like buying a winter coat during the spring sales, you should bulk up on supplies when you can, and never let them drop below a certain point.

Keep the deets

Most people do keep receipts, old tax returns, bills, etc. They keep them in a huge-ass box in a pile. Don’t do that. Find whatever works, whether it’s a service like, a spreadsheet, or an old-school ledger. Add shit up, and write it down. Find the leaks in your financial boat, and patch them.

I use a spreadsheet, and I discovered that during the most depressing stretch of my recent debt, I was treating myself to cab rides several times a month, sometimes several times a week. With all the stress, I couldn’t keep the details straight in my mind. Until I saw them added up with a total I didn’t like at the bottom. I managed to shave a few months off my debt repayment.

Credit leads to interest. Interest leads to bills. Bills lead to suffering.

It is an irony of the present financial system that the further in debt you are, the better your credit rating is. This has been documented over and over again in articles, films, and books, and doesn’t need a lot of elaboration.

The fundamental take-away is that many financial institutions’ main source of income, sometimes even before service fees, is interest charged on the debt you accrue. Keeping you hooked on as many ways to charge interest as possible is their best profit center, and so you are rewarded for inching towards bankruptcy, not away from it. It’s in their best interests (pun intended).

Overdraft. Lines of credit. Credit cards. Loans. There are more ways to access money before you’ve earned it than earning it. Pay attention when these services are offered to you. Sometimes, you are forced to accept them (I couldn’t qualify for a consolidation loan unless I accepted overdraft protection…this was a very easy way for the bank to allow me to spend money I didn’t earn, and charge me for it…it will be the first thing I cancel once my credit card debt is gone).

Don’t scrooge yourself

Pay attention to the small stuff, but not to the point of dying in a neurotic frenzy or denying yourself life. The last 3 years of my life have been a nightmare of receipts, interest rates, debt, endless piles of things I didn’t need at the time but couldn’t seem to wait for. Financing is a highwire act between what you want and what you require. Keep the scales balanced.

This hasn’t been about investing

Saving and investing are different topics. The former is about creating wealth, the latter about extending it. Before you can invest, you have to have something worth investing. So, the above advice is for people like me, who are starting back down the road to saving. In a few years time, I hope to begin the investment journey, as well.

Just don’t confuse the two. Many of my family and friends can save, some upwards of 40% of their earnings. But they can’t invest. It sits in low-interest accounts, or under their mattresses, and inflation eats away at it. Learn to save, then learn to invest.

Good luck with your finances. I hope you are in better shape than I am. Final disclaimer: not a financial dude; seek pro help.

A few good books on personal financing

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