Frugality can only take you so far on the road to financial independence. That’s because there’s a limit to how much you can save. We all need a place to live, food to eat, Netflix to watch. It’s right there on Maslow’s Hierarchy of Needs.
Strip your budget down to the bare bones and you’re still left with a skeleton of fixed and variable expenses; from mortgage or rent payments, to groceries, transportation, insurance, maintenance – the list goes on. And, at the end of the day, your savings rate is determined by that gap between your expenses and your income.
So why do we spend so much time talking about cutting out lattes and avocado toast, and almost no time talking about ways to increase income?
Ramit Sethi, author of I Will Teach You To Be Rich, makes a profound statement when he says:
“Stop asking $3 questions and start asking $30,000 questions.”
Mr. Sethi hates all the tired personal finance advice about making budgets and cutting out lattes. He says if you focus on the big wins instead, then you’ll never need to worry about the cost of lattes and appetizers.
One of his best tips is to cut back relentlessly on the things you don’t love so you can spend lavishly on the things you do love.
What is a $3 question?
Lattes are a perfect example. We’ve all heard about the Latte factor and how eliminating your $5 a day coffee habit can turn you into a millionaire in retirement. Great in theory, bad in practice.
If you like spending money on good coffee then why should you cut that out of your budget just to save $150 a month? And why would you do that every single year for the rest of your life? It doesn’t make sense. Find the $150 somewhere else.
What about interest rates on savings accounts? I get asked all the time, so-and-so bank just dropped its rate by 0.10 percent. Where should I move my money?
If you have $10,000 saved and earning 2 percent, and your bank drops its rate to 1.9 percent, that’s a loss of $10 whole dollars of interest over the course of an entire year.
Another example of a $3 decision. Netflix just increased its monthly subscription fee by $3. Should I cancel?
Do you enjoy watching Netflix? Yes. Can you afford an extra $3 a month to access hundreds of hours of content? Of course I can!
Credit cards. I always get asked which credit card is best for earning cash back or travel rewards. Most cards pay 1 or 2 percent back, depending on the spending category. You’re really delving into the minutia when you start comparing 3 percent on dining versus 4 percent on groceries. At most you’re squeezing an extra $100 out of your rewards – but that’s optimizing your spending with multiple cards.
I haven’t even touched on gas prices or coupon clipping. I mean, who has time to wait in line at Costco to save $3 on gas? Or to drive around to three different stores to save $3 on chicken?
Heck, I literally pay $4.95 to buy my groceries online and have Save-on-Foods collect the items and deliver them to my house. It’s one of the best decisions I’ve ever made.
What is a $30,000 question?
If you can’t out-frugal your way to financial independence then you need to look at the other side of the equation. How to earn more money.
I remember combing through budgeting spreadsheets trying to figure out how to pay down my credit card faster. I had student loan debt, credit card debt, mortgage payments, and probably had too many nights out on the town. But I was also earning just $26,000 on a one-year contract. There was simply no room to wiggle. I had to earn more money to start moving the needle on my finances.
I made it clear at my performance review that I wanted to stay on permanently, but not at that salary. Other employees may have been happy with simply having their contract extended. I negotiated a $13,000 raise, and some breathing room in my finances.
One year later I got passed over for a promotion. Instead of sulking, I got to work on improving the skills I was lacking, namely on the leadership side, and joined two community boards to broaden my experience. Six months later I was ready when the new director didn’t last beyond her probationary period. The net result: a promotion and another $13,000 raise.
Finally, when the hospitality industry was struggling and I had reached my ceiling in terms of earning potential at that position, I started looking for new opportunities. That landed me in the public sector with a $10,000 increase in salary.
There’s nothing more powerful than your human capital when you’re just starting out in your career. A $10,000 increase in annual salary at age 30 can compound into hundreds of thousands of dollars in lifetime earnings.
More $30,000 questions
Sometimes there’s just no room to negotiate a salary increase or move to a higher paying industry. Take it from someone who has been through five years of salary freezes before finally getting a 4 percent raise this year. The economy can be tough.
That’s why my big decision to start a side-hustle paid off. I’ve been writing about personal finance for nine years. When I started earning $100 or $200 a month, I thought – WOW – that’s our electricity bill. Years later the $100 or $200 a month turned into $1,000 or $2,000 a month. That’s a mortgage payment!
Now the side hustle has reached a point where it out earns my day job. It has provided our family with tremendous flexibility to reach our financial goals and add new ones.
A side-hustle can be anything you’re passionate about. It doesn’t have to be a blog, or web design, or anything to do with the Internet. Even in retirement, adding a part-time job at a golf course, hardware store, or yoga studio can be enjoyable and contribute to your annual income.
What about investing? Many of us ask the wrong questions about our investments and spend too much time chasing last year’s winning stocks or funds.
A $30,000 investing decision would be to switch to a low cost, globally diversified indexing strategy, whether through a robo-advisor or a do-it-yourself discount brokerage. The key is to save on annual fees AND automate your investments to prevent you from tinkering with your portfolio.
Your investments are automatically rebalanced when you use a robo-advisor. You can also get automatic rebalancing and diversification with a one-ticket ETF solution like the one I invest in – Vanguard’s VEQT. You’ll save hundreds of thousands of dollars in fees and increase performance over your investing life, compared to a conventional portfolio of bank mutual funds. Best of all, you can set it and forget it.
Credit cards. I changed my mindset around earning rewards and now focus on signing up for 3-4 new credit cards a year that come with massive sign-up bonuses. This new approach has more than doubled my credit card rewards and partially funded our trip to Scotland and Ireland.
Finally, what about increasing your savings rate? At some point in your life you decided to save 10 percent of your income and set up an automatic contribution. Ten years ago that might have been $400 per month. But now you make $80,000 a year, and so your $4,800 annual savings now makes up just 6 percent of your income.
Make a point of increasing your savings rate each year – at least move it up with your annual raise (if you get one) so your savings rate stays in-line.
Sometimes we pay off certain items like a car loan or line of credit. What do we do with the extra cash-flow? It probably goes back into lifestyle inflation, unless you have a plan. Allocate a portion to your savings and watch the compounding grow even faster.
Final thoughts
We win when we can make the big financial decisions count. For me, that’s meant negotiating raises early in my career, earning extra income with a side-hustle, keeping my investment costs low, and cutting transportation costs (no car payments).
Those big wins have allowed me to increase my savings rate to the point where I’ve fully maxed out my RRSP. Now I’m working on catching up on our unused TFSA room at a $2,000 per month pace.
Without a car payment we can shift those dollars to travel, something we feel really passionate about at this point in our lives.
The bottom line is to stop giving so much attention to $3 questions. You can’t cut your way to wealth. That doesn’t mean turning into a spendthrift. But automate where you can and focus your mind on $30,000 questions that will have a bigger impact on your finances.
In a normal interest rate environment, fixed rate mortgage tend to be more expensive than variable rate mortgages. Borrowers pay a premium for predictability – knowing exactly what their interest rate and mortgage payment will be for a five-year period.
For that reason, a common strategy for saving money on your mortgage has been to go with a variable rate mortgage. A widely quoted study by Moshe Milevsky showed that borrowers would have saved money nine times out of 10 by selecting a variable rate over a fixed rate mortgage.
Variable rates are tied to the Bank of Canada’s key interest rate, while fixed rates – broadly speaking – are closely linked to the bond market. What’s happening now is extremely rare. Five-year fixed rate mortgages have fallen below their variable rate counterparts. The going rate for a five-year fixed is around 2.69% while the best 5-year variable rate is 2.84%.
The reason for this upside down mortgage rate environment is because of something known as the inverted yield curve. In normal times, bonds with a longer maturity pay higher interest rates than bonds with a shorter duration. Yields may fall when investors believe the economy is due for a slowdown or recession. An inverted yield curve is when long-term yields fall below short-term rates. It does not happen often, but the event is believed to predict an impending recession.
My typical mortgage renewal strategy is to take the best of a five-year variable rate or a short-term fixed rate – as these tend to offer better discounts than five-year fixed rate mortgages. However, today the five-year fixed rate mortgage is being offered at a discount to the variable rate, AND at the same or lower rate than a 2-year fixed rate mortgage.
To me, that means the risk premium for a five-year fixed rate mortgage has temporarily vanished – making it a no-brainer for homeowners to lock in for five years. The one caveat I should mention is before locking in make sure you’re in a stable place with your work/life/finances because the penalties for breaking a five-year fixed rate mortgage can be steep.
This Week’s Recap:
I managed just one post this week – continuing my look at the best time to take CPP. This article explained why it’s not ideal to take CPP at age 65.
Previously, I shared three reasons to take CPP and age 70, and three reasons to take CPP at age 60.
Several of you have asked for a follow up on Old Age Security and if it’s worth delaying taking your OAS benefits, so watch for that article coming soon.
Promo of the Week:
Interest rates on savings accounts have been ticking down at most big banks and credit unions. Once a market leader, Tangerine recently dropped its interest rate to 1.15%. If you want to earn a higher rate on your savings then you need to look outside the big banks and consider an online bank.
EQ Bank has offered one of the best interest rates in the country since it launched in 2016. Its EQ Bank Savings Plus Account, which has also has some chequing account functionality, pays a healthy 2.30%* interest. That’s double Tangerine’s savings account and nearly triple what some of the big banks currently offer (short term promos aside).
What I like about EQ Bank is that it doesn’t mess around with short term promotions and teasers. It pays an everyday high interest rate – currently 2.30%* – on every dollar (up to a maximum of $200,000).
If you’re the type of person who likes to hold a large amount of cash, whether it’s an emergency fund or a short-to-medium term savings goal – do yourself a favour and start earning higher interest on that savings. Sign up for an EQ Bank Savings Plus Account here.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
Weekend Reading:
Sticking with the CPP theme, MoneySense’s Alexandra Macqueen answers a reader question: Could retiring at 61 significantly reduce your CPP benefit?
Jamie Golombek explains why running afoul of the CRA on RRSP withdrawals can be a costly mistake.
My Own Advisor Mark Seed walks readers through a retirement calculator he learned about from Fred Vettese’s Retirement Income for Life.
Michael James shares a useful analysis on Canadian listed ETFs versus U.S. listed ETFs. The point is, as your portfolio grows there are a number of cost advantages to using U.S. ETFs, namely lower MER and reduced or eliminated foreign withholding taxes.
I liked this article on how to protect your retirement portfolio from drawdown erosion, especially the idea of dividing your portfolio up into ‘buckets’ of short, medium, and long term monies. However, I didn’t like that it mentioned one of the most overused phrases in financial planning – ‘protection on the downside‘.
Investor advocate John DeGoey explains the life changing magic of low cost investing:
“This little bit of self-evident logic seems to be lost on many advisors, who continue to recommend unnecessarily high-cost investment products to their clients.”
De Goey also shares an excerpt from his new book on The Evidence-Based Investor blog, “You’re entitled to your own opinion, but not your own facts.”
In this interview with Dan Ariely, the behavioural economist shares his thoughts on the future of financial advice, including his positive experience using an advisor:
“I knew I wasn’t in tremendous danger to spend [recklessly]. But here was a guy that cared about me holistically. He wanted to know about the money I had outside of his bucket and would discuss quality of life and what kinds of things gave me happiness and so on. It was great.”
Here’s A Wealth of Common Sense’s Ben Carlson on the old investing line, “If you would have just invested $10,000 into the Amazon IPO…”
And Ben’s podcasting sidekick Michael Batnick on the opposite of conventional wisdom.
An alarming visual graphic of the countries most at risk of a housing bubble paints a stark picture for Canada, which ranked high in all four key housing market indicators.
Finally, a hilarious take on preparing for daily life with a newly retired spouse. Maybe it hits close to home for some readers. In any case, a good reminder to have a plan for how you’ll spend your time in retirement.
Have a great weekend, everyone!
A study published in the Canadian Tax Journal raised doubts about the effectiveness of Tax Free Savings Accounts and whether TFSAs really help Canadians save more. The study showed that one-third of TFSA contributions would have otherwise gone into RRSPs – something the authors called a displacement effect. Furthermore, the remaining 66 percent of contributions came from new savings or money funnelled from non-registered accounts.
And while 10 percent of contributors maxed out their TFSA contributions in 2009, the first year of existence, only 2 percent made the maximum contribution in 2015 (to be fair, that was the year the federal government increased the TFSA limit to $10,000).
The point of the TFSA was to complement existing registered savings plans, which limit the amount one can contribute to 18 percent of income in a given year. Should it be concerning that Canadians are shifting some of their RRSP dollars to their TFSA? Yes, if it means Canadians are saving less than before for retirement.
My take on TFSA use? Young people use it for short-to-intermediate goals, like a vacation, car, or house downpayment. No problem there. Older Canadians use it to shelter previously saved money in their non-registered accounts. That’s smart retirement planning. Wealthier Canadians use their TFSAs exactly as the government intended – now maxing out both their RRSP and TFSA limits each year.
Blame the banks for our lower TFSA uptake and continued misunderstandings about how the account works. After all, when TFSAs were first introduced in 2009 it was the banks who advertised it as a “high interest savings account.” Combine that with our lack of understanding about the contribution and withdrawal rules, plus the fact that TFSAs can be used for more than just cash savings, and you have one confused populace.
Finally, the flexible withdrawal rules make TFSAs prime for raiding the account to pay off debt, renovate the home, buy a car, travel, you name it. The fences around your RRSP, namely withholding taxes and paperwork, tend to stop us from raiding the account before retirement.
Has the TFSA been a disappointment 10 years after it was introduced? Hardly. The flexible account can be used for a variety of purposes, and Canadians of all ages are proving that to be true. I wish the TFSA had been there for me at age 19, when I was inexplicably contributing to my RRSP despite a low income and many short-term financial goals ahead of me. As a retiree, the TFSA will be a boon that provides tax-free retirement income that does not impact means-tested benefits such as OAS.
This Week(s) Recap:
We got home safe and sound late Monday night after a 22-hour day of travel. Not without incident, however, as we discovered a nail in one of our tires when leaving the Calgary airport parking lot. Seriously. After a quick trip to Canadian Tire we got the tire replaced and managed to get home safely.
I’m thankful that our return flight, which was originally scheduled to arrive in Calgary at close to midnight, was changed to arrive at 6:30pm, so we were able to find an open tire shop and didn’t have to spend another night in a hotel.
I managed to write two posts since my last Weekend Reading update from Ireland. The first gave a mid-year update on my net worth. It’s incredibly motivating to cross the $750,000 mark and get closer to my goal of becoming a millionaire by the end of 2020.
The second post looked at doing things the easy way or the hard way and compared Canada’s mutual fund industry to paying the full retail cost of a direct flight.
Promo of the Week:
I cannot speak highly enough about the Scotia Passport Visa Infinite card, which I used predominantly on our trip to Scotland and Ireland. I got it for the no foreign exchange fees and juicy 25,000 point sign-up bonus. But what really impressed me was the instant email notifications each time I made a purchase overseas. It allowed me to easily keep tabs on our budget (in Canadian dollars), which came in handy for a month-long vacation.
One final word about using credit cards abroad. Often you’ll get asked or prompted to make the purchase in local currency or in Canadian dollars. Always choose local currency to avoid any hidden mark-up or fees charged by the retailer or merchant.
Weekend Reading:
Something I’m sure we’ve all felt at some point in our lives – is everyone richer than me?
Mike, The Dividend Guy, quit his job in finance two years ago to focus on his blog and shares the dream, frustrations, and achievements.
Mark Seed sold his home and moved to a condo in downtown Ottawa. He shares his moving survival tips here.
Personal finance gurus (not me!) really hate coffee. Here’s a good take on why buying coffee won’t make you poor.
“Finance traditionalists might have notched a victory or two along the way, but their war against Starbucks and its ilk was over before it had even begun.”
Ben Carlson explains why everything we think we understand throughout history is probably at least a little wrong.
In his latest Common Sense Investing video, Ben Felix explains why it’s wrong to evaluate your investment decisions based on its outcome:
Decumulation is one of the greatest financial planning challenges. Here are three common mistakes retirees make when drawing down assets.
Winding down an RESP account is another tricky endeavour. Here’s Frugal Trader using a GIC ladder for RESP withdrawals.
Michael James helped a friend buy a car and wrote about estimating the value of 0% financing.
Finally, Dale Roberts and the newly redesigned Cut the Crap Investing blog looks at whether retiring baby boomers will destroy the stock market.
Have a great weekend, everyone!