One of the things 2020 has reminded us of was the importance of money management. Back in April, the pandemic has taken away millions of jobs overnight. Despite a few months of recovery, we have already realized anyone can experience job loss at any moment. Our bills, sadly, don’t stop just because you lost your job. Depending on where you are, you might or might not have received government assistance. Unfortunately, these subsidies often don’t come fast enough or don’t last forever. As 2021 is fast approaching, the reality is we still don’t know when the economy will fully recover. However, one thing is for sure: it is more important than ever to better manage our money so we will be ready for whatever comes next.
In an effort to help you get started, I am sharing 5 tips to help you manage money in 2021 and beyond.
Money Tip #1 Know What Your Net Worth Is
How do you get better at managing your money if you don’t know what is there to manage? The answer is you don’t. Therefore, the first money management tip I have for 2021 is to find out what your (or better yet, your family’s) net worth is.
If you have never calculated your net worth before, it’s simpler than you might have thought. In most situations, there is no need to get a banker or accountant involved (however, it is recommended you do so if you aren’t comfortable and/or the service is offered by your financial institutions for free). The basic formula for calculating net worth is this:
Everything You Own – Everything You Owe = Net Worth
For those of you who would like to try this on your own (highly recommended as it will be a discovery journey), I have detailed the step-by-step process in this two-part how to prepare for a recession series.
Money Tip #2 Know How Much You Make And Spend
Once you figured out where you stand financially (i.e., what your net worth is), your next step would be to find out how much you make and spend every month. Note, it is normal for both income and expense to fluctuate every month depending on your employment situation and lifestyle. However, the average should be used when possible. For example, if my quarterly (3 months) water bills are about $300, I would enter $100 for the water bill per month. This way, your income and expense report would be reflecting your living expenses most accurately (i.e., use $100 water per month instead of $0 for two months and $300 for the third month).
Note, caution should be used if the average method is used to forecast cash required per month.
Money Tip #3 Take Advantage of RRSP & TFSA
Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plan (RRSP) are registered investment accounts offered by the Canadian government. There are a lot of resources out there such as this video and this article that talk about the similarities and differences between the two in-depth. Depending on your income level, financial goals, age, career path and family composition, there are advantages and disadvantages for either one of them. However, they are almost always more superior options than non-registered investment accounts.
But, simply putting money in your TFSA and/or RRSP is not really taking advantage of either one of them. Depending on which one you go with (or both), you would only benefit fully if you take advantage of the tax-free earnings (TFSA) or increased investment amount (RRSP).
A recent study conducted by BMO reported that cash is the primary investment in TFSA. This is a big no-no unless the money is your emergency fund in which you will need to access quickly all of a sudden. In all other scenarios, leaving your “investment” in TFSA and/or RRSP as cash (not even in a high-interest savings account) will provide you with little to no benefit.
Let’s use TFSA as an example. If you were at least 18 in 2009, you would have accumulated $69,500 contribution room in 2020. If you had opened your first TFSA account on Jan 1, 2020, and contributed the maximum amount ($69,500) and bought nothing but the iShares Core S&P U.S. Total Market Index ETF*, it would have grown to $79,002 (or 114% of initial investment)*. That translates into a gain of $9,500 that is completely and legally tax-free! If your marginal tax rate is 30%, you just saved close to $3,000 in tax.
Do you see the potentially huge value of taking advantage of these two registered investment accounts?
*as of Dec 19, 2020 which is the publication date of the post
**for illustration purposes only as I do not recommend investing all your money in one stock, even if it’s an ETF (Exchanged-Traded Fund)
Money Tip #4 Know The Opportunity Cost of Every Purchase
If you have taken an introductory economic class before (which I highly recommend everyone does no matter what major or career you are in), you would have learned about the concept of opportunity cost. To put it simply, it is merely the realization that when you spend the money on A, you no longer have the money to spend on B, C or D. This concept is actually applicable to any finite resource such as time.
Before I started working from home, I used to buy Starbucks for my daily commute to work and sometimes even on the weekends. Even though I don’t drink the fancy lattes, my grande cup of brewed coffee still added up to about $750 a year. However, I had never thought about stopping because I was aware of the opportunity cost of the coffee. $750 could be a pair of dream shoes that I might wear once or twice a year, a very nice handbag that I might use a few times a month, a new phone to replace my old one that still works or a two-night stay at a 4-star hotel. Instead, what I spent it on brought me happiness every morning on my way to work.
By understanding the concept of opportunity cost, you will become more conscious about your spending and actually experience less guilt when you “splurge.” Some people might think it is wasteful or cost-prohibitive to get take-out coffee every day, but only you can decide what is worth your hard-earned money and give up what is not for it.
Money Tip #5 Talk To Your Significant Other/Family About Money
What I have learned from the couple money management books is that money issues are often the cause of marital and family conflicts. Talking about money is also not encouraged or is almost considered taboo in some cultures. Having experienced this cultural belief myself growing up, I can see why couples and/or families don’t talk about money as often as they should.
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However, it is absolutely critical for you to be on the same page as your significant other and/or family on the topic of money. You don’t necessarily have to agree on everything (which I am not even sure if it’s possible) but you have to agree on major issues that have a profound impact on one or both of you and be aware of the other party’s views. For example, if one party is in major credit card debt and the other party has been saving up towards his/her first home, the last thing they want is to find out too late (i.e., when they want to make an offer on their dream house).
The first few talks might be tough and they might even get emotional. This doesn’t mean you should avoid talking about it. Like all new skills, the art of talking about money requires practice, patience and most likely compromises. However, you can’t work towards a future together without taking finances into account.