In order to determine your ability to save you need to
- create and review a Household Budget &
- determine a savings rate
The calculation of your savings contributions or ability to save is based upon the Household Budget that you completed in Step 1 of the Portfolio Design process. As stated previously, budgeting and specifically the act of saving, is the source of your investment capital. If you cannot save, you will not have to worry about investing and designing an investment portfolio because you will have nothing to invest.
Creating a Household Budget
Creating a Household Budget of your family’s income and expenses is not so much about critiquing your family’s lifestyle as it is about ensuring that you are making the most of what you earn. There are two goals to creating a Household Budget:
- The first goal is to make sure that you are not throwing your money out the window. Once you have a detailed summary of your income and expenses, then you can analyze each line of expense to ensure that you are not spending more than you need to for the same service and lifestyle.
- The second goal is to ask if your family actually benefits from each itemized line expense. (For example, if three family members have separate cell phone plans or gym memberships, maybe using a family plan can reduce these family expenses. Maybe you and your partner are each paying individually for dental, medical, and prescription coverage through your employers when one plan could cover the family. Can one expense be eliminated without reducing your family’s coverage?)
Remember: Most of us build our current lifestyles as a result of a thousand individual decisions made over years and years of living. Very rarely do we sit down and re-examine our individual decisions to ensure that we are maximizing our lifestyles while minimizing our expenses. A detailed Household Budget of items can assist us in making sure we are not throwing our money out the window. By reviewing and analyzing our summary, more often than not we discover surplus money that we can allocate to savings and investing or to pay down our debts. Our goal is to help you establish achievable financial goals, increase the money available for savings or debt repayment, and design a portfolio that can support your success in reaching your financial goals.
Determining a savings rate
Once you have reviewed and adjusted your expenses, you will have a better idea of the dollar amount that your family can save and invest each month and year. The dollars allocated to saving for your financial goal is your savings rate. It doesn't matter what the dollar amount is. It is more important that you start the habit of saving. If $100.00 per month is achievable then start with this amount. If in the future your income or your expenses change, you can always revise your savings contributions.
Note: At InvestingForMe, a member’s Savings is listed as an expense in our Household Budget. We treat contributions to RRSPs, TFSAs, and taxable accounts as expenses. Savings should be an expense just like your rent or mortgage payment because your financial goal is simply no more than a large future expense that is better dealt with in baby steps – saving each month. However, in our Retirement Budget Estimator, we remove RRSP, TFSA and taxable account contributions from the anticipated expenses because it is assumed that a retiree will no longer be saving.
Just as with your financial goal’s estimated Time Horizon that you established in Step 3, your savings contributions may also need to change to ensure that your financial goals are achievable. You may also want to review and examine each line of family expenses more than once to ensure that you are satisfied that you have maximized the value from the product or service and minimized the expense.
In addition, once you have determined the amount of monthly or annual savings that your family can generate, you will then have an important decision to make. If your family has a mortgage or consumer debts, should you allocate your savings to reducing these debts, invest your savings, or a combination of both? Each family and individual will have a different philosophy on the best allocation of your savings, so you will need to decide which is best for your family’s circumstances.
Members' Note: InvestingForMe provides a more detailed discussion of the allocation of savings in our Financial Planning and Budgeting sections.
You are now ready to go on to Step 5: Calculate your Required Average Annual Rate of Return