How to save?

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How to save? How to invest?

Put money towards your savings every month

Without savings there is no flexibility, you can’t make choices, you are stuck to a budget that does not allow you to reach your goals and if your level of income does not keep with the inflation rate your standard of living is eventually downgraded.  Savings provide security for the future and helps prevent the unknown, starting a saving plan is an important step for good financial health. Whenever we hear the word “savings” we tend to think this only refers to our retirement savings, but that’s not the case. Yes, a good retirement plan is important but we need to save for other things in life too, like a vacation, a new appliance and an emergency fund.

Having an emergency fund is crucial for a good budget to survive. All it can take is a bad muffler or an unexpected dental bill to completely throw a wrench in your budget. If you haven’t been putting a specific amount of money aside each month to cover these inevitable yet “unexpected” expenses, you’ll find yourself in trouble and most likely relying on credit to get you through it. You should avoid using credit cards for emergencies — it’s the worst emergency plan you can have due to the interest rates they charge. Plus, if you can’t afford to pay for an unexpected cost when it comes up, you likely won’t be able to pay for it next month when your credit card bill arrives either.

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Saving starts with a conscious decision to cut everyday expenses. However it’s not enough to simply save money if you want your savings to outpace inflation, you have to invest.  Invest is a miracle to your savings when they grow similar to a plant that gets well take cared.  In the same way not all plants grow the be strong and produce flowers, investment is a delicate task that needs research and timing because it is risky.   A good investor is therefore the one who is aware of the risk inherent in each investment and can use this information to time the perfect moment to buy and sell an asset, just like with plants knowing when the rain season will benefit your crop.

How Much Should you Save vs. Invest?

Saving money should almost always come before investing money. Think of it as the foundation upon which your financial house is built. The reason is simple. Unless you inherit a large amount of wealth, it is your savings that will provide you with the capital to feed your investments. If times get tough and you require cash, you’ll likely be selling out your investments at the worst possible time. That is not a recipe for getting rich.

There are two primary types of savings programs you should include in your life. They are:

  • As a general rule, your savings should be sufficient to cover all of your personal expenses, including your mortgage, loan payments, insurance costs, utility bills, food, and clothing expenses for at least three to six months. That way, if you lose your job, you’ll be able to have sufficient time to adjust your life without the extreme pressure that comes from living paycheck to paycheck.
  • Any specific purpose in your life that will require a large amount of cash in five years or less should be savings-driven, not investment-driven. The stock market in the short-run can be extremely volatile, losing more than 50% of its value in a single year.

Only after that these things are in place, and you have health insurance, should you begin investing. 

What should you invest in?

As mentioned before, you should pick investments where you know the risk involved in order to determine if this asset matches your risk tolerance.  

What is your risk tolerance?

To explain this concept we will use the following situation.  Imagine you have to take a plane to go from New York to London and there are two airlines that offer the closes departure at the same exact time from Ney York however airline A gets into London tomorrow morning at 9 am and Arline B gets into London tomorrow afternoon at 2 pm. Which airline would you pick?  The most common answer for this question has been airline A arriving into London tomorrow morning at 9 am, however we forgot to mention one slight detail about airline A, which is that during the flight during sunrise the flight will experience significant turbulence with annoying bumps that would feel like the plain is thrown out of control with oxigens masks coming down the roof and passengers screaming for help thinking that it is the end of their lives, however the plane safely arrives at London at 9 am on the next day.  After the description of this scenario, which airplane would you take? A or B? If you still chose airplan A your risk tolerance is higher than those who chose airplane B.  Both airplanes will get into London but one will be arriving earlier than the other one which is in essence the price you pay for a riskier investment with a higher return (in this case, arriving earlier).  The trade off between having an extra benefit in exchage of risk is known as the risk vs. return tradeoff.

As you saw in the previous example not all investments are made for every investor.

What are the most common types of investments?

There are various ways to invest your money, such as stocks, bonds, and property. You should have a clear understanding of each option and the risk return trade off each offers in order to make the best decision for growing your money.

  • Common Stock: A share of common stock represents ownership in a legally formed corporation. For most companies, there is a single class of stock that represents the entire company. However, some companies have multiple classes of stock, including dual classes of stock . Often, one class of stock will have more voting rights than another class of stock. Owners of common stock are entitled to their proportionate share of a company’s earnings, if any, some of which may be distributed as cash dividend. The best stocks are usually referred to as blue chip stocks. Stocks are volatile thus offer more risk return trade-off
  • Preferred Stock: Preferred stock is a class of ownership that allows shareholders of a company to get a larger dividend, and that dividend is often guaranteed. Holders of such stock do not have voting rights, but they can receive special status if a company heads into insolvency. If a company is being liquidated and creditors need to be paid, preferred stock shareholders must be paid before common stock shareholders. In some cases, companies can repurchase shares of preferred stock from shareholders, often at a premium. It is also possible to convert shares of preferred stock into common stock, but not vice versa. Preferred stocks are less volatile than common stocks but still offer more risk return trade-off.
  • Bonds: In simple terms, a bond is like a loan. When you buy a bond, you are usually agreeing to lend money to a government or a company. Typically, the bond issuer promises to repay the entire principal loan amount on a future day, known as the maturity date, and pay interest income in the meantime based upon a coupon rate. There are many types of bonds, including those issued by governments, such as Treasury bonds and municipal bonds. These bonds are often used to fund government operations and capital projects. There are corporate bonds which help companies fund their operations and invest in themselves. There are investment grade bonds AAA-rated bonds and on the opposite end of the spectrum junk bonds. If you do not want to buy bonds individually, you can invest in bond funds. Bonds have less risk return trade-off than stocks.
  • Real Estate:  Real estate is tangible property, such as land or buildings, that the owner can use or allow others to use in exchange for payment. When you own a house, you own real estate. When you own a plot of land, you own real estate.  Real estate offers less risk return trade-off thank bonds and stocks however it has other risks such as liquidity risk and concentration risk.

The best way to invest is to do it yourself through an online broker. Here is Moneylesson recommendation for the lowest cost online brokerages in Canada.

Our recommendation is based on the fact that Questrade does not charges annual fees regardless of account size, and there is not fee to purchase ETFs (exchange trading funds) which are the investment vehicles that carry the lowest management fees. So you can build an portfolio with ETF’s for free. Bear in mind that if you trade stocks or bonds there will be a trading fees that ranges from $4.95 to $9.95, and their account minimum is $1,000. If you move an investment account from another brokerage Questrade will reimburse transfer fees up to $150 per account. The app is on of the top investment trading apps and your funds are covered by The Canadian Investment Protection Fund, which means your assets are covered, off course not your investment risks. Take a chance to open a questrade account and either get 10,000 managed for free or 50 dollars towards trading fees.

How we can help?

If you don’t have a financial plan we can help you set up one for free.

We empower Canadians to manage debt wisely with a Financial Plan. We believe that everyone deserves an unbiased financial plan to be able to achieve their goals. Since 2010 our Mission has been to promote financial literacy among Canadians through the reinforcement of saving for a purpose, self budgeting and conscious spending.

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