The best piece of financial advice I ever received came from one of my aunts who, when I was three years old, told me: “Don’t put pennies in your mouth. They are dirty and you don’t know where they’ve been.” A close second to this sage advice came fifteen years later when a financial advisor told me: “Pay yourself first.”
The idea behind this advice is that you may be making enough money now to cover your bills, but your future self might not have enough income to cover their expenses. Most of us will eventually retire, many of us will go through periods of unemployment, some of us might need to pay medical bills one day, or buy a house, or replace a vehicle. In short, your budget might balance today, but who knows what tomorrow will bring. Having a cushion – whether it is money in the bank or investments – we can pull from will make future challenges much easier.
While having a financial cushion set aside for our future selves sounds like a great idea in theory, a lot of people struggle to create this pool of cash. One of the reasons for this is we are here (right now) and there are things we want (right now) and we have rent to pay (right now). Setting aside money we will need a few years from now usually doesn’t feel like a priority. Often times people will, at best, set aside money into savings or investments when they have a surplus – like when they have a bonus or some overtime pay. Many don’t put money away as a regular month-to-month activity.
This is why I tell people “Pay your future self first.” The idea here is not to wait until you have a windfall or a bonus or you get a promotion at work. Paying your future self so you have an emergency fund or can retire someday is a habit which should be started right away and practised as long as you have income. When making up your monthly budget try to make the first item on the list “pay future self” and decide to set aside a set amount of money each month that you won’t touch, except in emergencies. This amount you put aside can go into a high interest savings account (HISA) or a tax free savings account (TFSA) to be used in times of need. Once you have a solid safety net of funds, maybe enough to live off of for three or four months, then you might consider investing your monthly payment to your future self.
How much should you put aside for future you? This amount will vary a bit depending on any number of factors. If you’re making minimum wage or supporting a family on a single income it will be difficult to set aside any money for the future. On the other hand, if you’re in a well paying job with few expenses you might be able to put nearly half your income into investments for the you-of-the-future. I generally recommend people start out putting aside 10% and then, any time you get a bonus pay or a raise, try to increase this amount. If you can’t put aside 10% for the future, put aside 3% with the intention of increasing the amount later. Paying yourself a little is better than paying yourself nothing at all.
How much does putting aside this money, especially small amounts, help? Well as an example, let’s say you were to put a relatively small amount, perhaps $25 per paycheque twice a month, into a registered retirement savings plan for 30 years. That’s probably around 2% of your gross pay if you make minimum wage in Canada. When you retired you would have put aside $18,000 from just $25 per cheque. At a fairly conservative growth of 5% on your investment, your RRSP would grow to over $41,000.
Let’s say you get a few raises or a job that makes a little more and you’re able to put $100 per pay into your RRSP twice a month. You’d end up paying your future self $72,000 by the time you retired. By investing conservatively your retirement fund would reach $166,000.
The challenge is to budget for this small amount of money, whether it’s 2% or 25% of your paycheque, and diligently paying your future self every month. It’s tempting to use the money for something you want or entertainment or a vacation. But these things are extras and should be budgeted for separately. Your future self should be paid first and the money set aside for future you should only be used in emergencies or when you retire.
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