I try to take one day at a time, but sometimes several days attack me at once.
~ Jennifer Yane
I’ve written a lot of “vs.” posts comparing various financial priorities like RRSPs vs. TFSAs and RRSPs vs. Paying Down Debt. I still understandably get a lot of questions about which of these to do first and how to put financial priorities in order. Should you take them on one at a time or try to tackle them all at once? As usual, a lot of that will depend on your unique situation.
We are constantly bombarded by advice that tells us that we need to be maxing out our RRSP contribution room, our TFSA contributions, and saving for an emergency fund. We also need to pay down consumer debt, and try to eliminate our mortgage as soon as possible. What? You’ve got a couple of kids? You opened an RESP the day after they were born, didn’t you?
As I’ve said before, there’s only so much income to go around and it can be pretty easy to feel like you’re falling behind if you can’t take care of all of these things at once. That’s a dangerous place to be, because it can lead you to give up and stop trying. In terms of priorities, I would suggest you take a look at Your Financial Hierarchy of Needs. It’s a good place to start in terms the order in which you should address your financial needs. I’ll go over the basics here:
1. Spend Less Than You Earn: Even if you don’t have time right away to set up a detailed budget, at least jot down a draft idea of how much money enters and leaves your balance sheet each month and each year. Even a ballpark estimate is better than nothing. But please do set up a more formal budget when you can.
2. Establish an Emergency Fund: In order to keep from going into debt to pay for unexpected expenses like car repairs or broken appliances, an emergency fund is essential. In fact, Mr. Cents is out buying a new iron as I write this because ours burst into flames while he was doing a cleaning cycle with it. It burned a small hole in the bathroom counter! This should have been a preemptive purchase. Mr. Cents asked me last week if we should pick up a new iron as the model we have was on sale. I elected to be cheap thrifty and wait it out. Oops!
3. Pay Down Consumer Debt: Consumer debt usually refers to debt other than your mortgage (ie. credit cards, line of credit, retail financing, etc.). It should be paid down first because the interest rate on this type of debt is usually much higher.
4. Pay Down Your Mortgage: Don’t just accept a mortgage as an inevitable lifetime payment. Look at a mortgage calculator to see how much money you can save over time just by paying a little extra on your mortgage. It’s one of the safest investments you can make and what could be better than securing the roof over your head?
5. Save for Retirement: We will all need to be financially independent one day and the sooner we can begin saving, the better. If you are in a lower tax bracket, I would recommend contributing to a TFSA before an RRSP. If you are in one of the top 3 tax brackets, you may want to take advantage of the RRSP tax deduction and use the tax savings to pay down your mortgage or contribute to other savings like a TFSA or RESP.
6. Save for Education or Other Dreams: If you have children and want to help them fund their education, this is where you can do it. I put it after your retirement in terms of priorities because your kids can get a loan or work to pay for their education. If you have to stop working and retire earlier than you’d like, you won’t be able to get a loan or earn income. You need to look after your future, even if it means you can’t help your kids out as much as you’d like.
Does this mean you need to focus on these steps one at time and in this order? At that rate, you may be saving for your kids’ education just as they graduate from university! The first 2 steps should be done in order. After that, you have a little more slack. Your choices will depend on the level and stability of your income, your age, and above all, your ability to control your spending.
The Cold Hard Truth
One thing that I would like to emphasize is that the emergency fund should be a top priority. It’s a good idea to save at least $1000 for emergencies even before you attack your debt. This will ensure that you won’t dig a deeper debt hole if an unexpected expense pops up. Of course, it only works that way if you are spending less than you earn. That’s a prerequisite for any form of financial success. You’ll never save any money if you spend more than you take in. That’s just a mathematical fact.
Paying Down Debt
OK. You’ve got $1000 saved. The steps say that paying down debt comes next. Does that mean that you can’t save for retirement at all until you’ve paid off all of your debt? Well, that’s one way to approach it and there is some merit to it. (See RRSP vs. Paying Down Debt.) But many people are justifiably uncomfortable with saving nothing for the future, especially if they’re getting a late start or their debt load isn’t particularly onerous.
One solution might be to just contribute a minimum amount (even as low as $10 a month) to a TFSA in order to establish a habit of saving. Once your consumer debt is paid off and your mortgage principle is on the decline, you can gradually increase your savings as your income warrants.
There are a number of approaches out there to paying down debt. This is where the focus comes in. I would direct you to The Magical Penny for a nice primer on How to Pay Off Debt. Choose an idea that you think will work for you. If it doesn’t, don’t give up. Just try another. Keep trying until you find a method that works for you, even if you have to invent your own. If you do that, make sure you share it with the rest of us so that we can benefit from your genius!
Focus Over Diffusion
My personal preference is to choose focus over diffusion. I feel better when I can see significant progress on one goal rather than a little progress on many goals. But choosing a focused approach means that you need to have the discipline to really plow some money into your goal. The purpose of focus is to achieve your goal sooner. If you choose to work on one goal, you need to be able to put all of your resources into that one goal. Once that goal is accomplished, you need to maintain your spending discipline to tackle the next one.
What works for you? Do you prefer to focus on one goal at time or several at once?