All posts by Robert

Matching expenses to income

This is a guest post by Robert, who lives in Calgary and worked as a financial adviser before retiring at age 35. He is married, has three kids and has returned to school with the goal of eventually living and working overseas.

My wife recently began a new job, and she decided to buy a new car to go with it. The finance rate was cheaper than our mortgage rate, so we decided to finance the car. Consequently, we needed to decide when we want to make the monthly payments. The decision really doesn’t matter, financially, because it doesn’t change the cost of the car.

I suggested that we use the idea of matching to decide. My first suggestion was that we match the car payments  to her paycheque. She is paid bi-weekly (26 times per year), so it would make sense to have the car payment come out of the bank account the day after each paycheque. In the end, we decided to make the payment once a month, around the same time as our mortgage payment and credit card payment come out of our bank account.

When I worked as a financial planner, I heard from clients how awkward it can be to have all payments come out of the bank account at once, when payments into the bank account are made twice a month. The experience they had was of having “lots of money” in their bank account for half the month, then very little in the account during the other half. It made them feel alternately rich and poor. So what I would suggest was to better match the expenses with the income. As much as we were able, we would have half the expenses come out after the first paycheque, and the other half come out after the second paycheque.

Now that I don’t work, I have made a habit of looking at our bank account once a month and transferring in cash from our investment account if needed. Since all the expenses come out at once, I only have to ensure there is adequate cash in the account once a month.

Another way that some people match expenses with income is to set up a savings account. From a financial perspective, there’s no benefit to having separate accounts or mixing all the funds in a single account. But when saving for a large expense, such as a car or a vacation, it makes sense to save the money in a separate account, so that it can all be paid from that account later. That way, there is less temptation to spend the money on impulse items in the meantime.

Do you match your expenses to your income, either by timing or by account? Do you have another way to organize your budget?

My New Motto

Yesterday was a snowy day at my house. On top of that, it was daylight savings, so I had an extra hour. I spent most of the day reading in my warm, cozy house. (If anyone is interested, I chose Turn the Ship Around, by L. David Marquet, which I greatly enjoyed.) I don’t read as much as I used to, mostly because I’ve been busy with other projects. But when I do read, I often discover or formulate new (to me) ideas that I could apply to my finances.

My new motto is: Instead of reacting to things that happen to me, I will make things happen.

Instead of reacting to unforeseen costs or unplanned spending, I will plan ahead to have more than enough for the monthly basics, knowing that unexpected costs seem to come up regularly, even if they come from varying sources. In my budget, I only plan uses for about 90% of my income, leaving the other 10% as a cushion for use as needed. If the money isn’t used, I allow it to accumulate, since surprises are sometimes large (eg. repairing a car, replacing a refrigerator, etc.). After about six months, however, I’ll deposit the money into an account where it is easily accessible, such as a savings account at the bank or in a TFSA.

Instead of reacting to the market, I will plan ahead and stick to my investment plan. When the market is up, I buy. When the market is down, I buy. Each month, I invest my savings in the market, knowing that it will rarely work out to be the perfect time to invest, but it’s better than not investing at all, or guessing wrong with one big deposit. Sometimes, it’s possible to see that the market is uncharacteristically low (eg. spring 2009), but that doesn’t mean that a recovery is imminent. I invested a relatively large deposit in 2009, and it has helped, but not as much as having an automatic, monthly investment plan in place.

Instead of reacting to taxes, fees and other leakages, I will create a financial plan and follow it. I was fortunate to be trained as a financial advisor. Some of the things I planned (and did) to reduce taxes, fees and future costs were: make regular RRSP deposits, direct a large portion of my RRSP deposits to my wife’s spousal RRSP, set up and fund TFSAs for each of us, set up an RESP for the children, write of interest on investment loans and claim charitable donation and education tax credits on the higher tax bill (mine). Working with a financial planner may not help your investments perform better, but there can be great benefits from organizing your finances in the most efficient way.

A lot of time and energy can be expended reacting to issues as they arise. Mistakes can also happen. Instead of reacting, taking control, looking ahead with a plan and putting the plan into action helped me to be relaxed about my money, knowing that I was well prepared and getting the greatest benefit possible. What aspect of your finances do you need to take more control over? What purpose or goal are you trying to achieve with your money?

Compensating for Bias

This is a guest post by Robert, who lives in Calgary and worked as a financial adviser before retiring at age 35. He is married, has three kids and has returned to school with the goal of eventually living and working overseas.

There has been a lot of talk among economists and investors about human biases under the heading Behavioural Economics. People aren’t nearly as rational as economists assumed in their early work at modelling transactions and decision-making. We have predictable tendencies to exaggerate losses, to overestimate our resiliency to risk and to be overconfident about our ability to predict the future.

Our biases make it more difficult for us to be successful investors. How many people, when the market drops, focus too much on their paper losses, panic and want to sell their investments? How many people, when the market crashes, sell at the bottom and swear off investing forever? I know from my experience working as a financial advisor that the (admittedly imprecise) answer is: too many. The money that many people pay for investment advice pays not only for advice on investment opportunities and asset allocation, but also babysitting to avoid selling investments at every market correction, and to avoid getting sucked into enticing investments that offer 17% guaranteed returns (seriously, I’ve seen this), but is simply too good to be true (and I’ve seen it go bankrupt).

So let’s be honest with ourselves. Saving money is hard. We’d prefer to have something now rather than delay our purchase into the unpredictable future. It’s harder for some people than for others. But as long as we’re being honest, there are ways to compensate for the difficulty. As an example, having the employer deduct a certain amount of savings from every paycheque. As an example, a friend was telling me yesterday at his work that most of his colleagues can only have 1% or 1.5% withheld for the company savings plan, despite 100% matching from the employer (free money!). It’s because they live paycheque to paycheque and $100 makes a difference. I wonder if they would be able to increase their savings by 0.5% every six months or every year, without feeling the pain. I also suggested to clients that every time they get a raise, half of it be redirected toward savings. Being realistic allows us to work around our biases.

Facing reality also means knowing that the stock market is going to be volatile and fluctuate, sometimes wildly. In my research, I have found very few good reasons to own a diversified portfolio of stocks and bonds. Sometimes stocks perform far better. Occasionally, bonds perform better, while being far safer. These two investments have different purposes, in response to different investment needs. The benefit to an individual investor of buying a portfolio that’s 60% stocks, 40% bonds is that the ride will be smoother, the individual will have less opportunity to experience “losses” and will be less likely to panic. But in some cases, that can be a very real benefit.

Being realistic and honest with yourself is likely the best way to manage investment risk. Expect a small return each year, expect bad years once in a while, and expect to have trouble saving as much as you’d like. Then find ways to compensate for those difficulties. How honest are you with yourself about your investments? What do you do to compensate for your biases?