Step 2 – Where do you want to go?

What’s your financial destination?

RECAP – What do we know?

Now that you know where you are financially, you can ask yourself, “Where do I want to be?” and “By when?” The difference between where you are today and where you want to be and in what time period, is important for the development of your personal strategy.

You may be saving to buy your first home or you may be saving to retire or you may be "independently wealthy". Step 2 is most relevant for those that are saving for retirement. The following explains why:

Independently Wealthy


Independently wealthy means that your financial position is what you need or is more than what you need to live your life as you would like.  If you are independently wealthy, go to Step 3. If you’re not sure whether you are independently wealthy, a reasonable test is if 4% of the value your portfolio less anything you owe plus any other income you receive like a pension, is equal to or is more than what you spend each year. For example:

  • Assume a family spends $200,000 per year after tax and receives a pension income after tax of $40,000 each year.  Therefore to be independently wealthy, their portfolio needs to generate an after tax income of $160,000 each year ($200,000 less $40,000).  Based on a 4% after tax return assumption, they require a $4 million portfolio ($160,000 divided by 4%), to do this.  

  • Or let’s assume you spend $100,000 per year after tax and you receive pensions that after tax equal $60,000 per year. Then your portfolio has to be $1 million in order for you not to require any further savings ($40,000 divided by 4% - the amount you require from your portfolio every year divided by 4%).

Using an after tax return of 4% each year on a portfolio is a good estimate for anyone.  In real life what your portfolio makes will be different each year.  And your after tax return will be influenced by how your portfolio is managed.  However, it provides a good ball park estimate.

Saving to buy your first home


If you are saving for your first home or a similar type asset, make sure that your monthly savings will equal the amount you need over the number of years you’d like to save – at a minimum. For example:

  • Let’s assume you want to save $25,000 for a down payment on a home and you hope to do this over the next three years, then your monthly savings need to be at least $695 per month ($25,000/36 months).

    - With respect to how to invest these savings, please use conservative investment vehicles that will not vary in price over the period you are saving. For example, GICs at your bank or credit union, government savings bonds, savings account, treasury bills or money market funds.

    - For those of you in this position, although your focus is on saving for your new home, put a small amount aside each month into your RRSP or TFSA. This can be any amount per month from $25 per month or higher.
         When you are starting to save and until you reach approximately $5,000, consider using a balanced mutual fund to put the monthly savings into. To select the best mutual fund for you, I recommend you move to Step 3 to review and understand your personality as an investor and then move to Step 4 to learn how to select this fund.

    - I would also recommend you continue to read so that you can begin to think about your plans for investing after you have bought your home as this process takes some time and thought. There is no time like the present to start to become informed.

Saving for Retirement

If are saving for retirement, then I expect you need some conservative savings for a “rainy day” as well as a long term investment strategy for your assets that you are growing for your retirement. In this case, your annual savings need to be sufficient for near term needs like education for children or a larger home or a recreational home or a “rainy day” fund as well as funds long term investment strategy for your retirement.

It is really difficult to know how much you’ll need in retirement as life changes so often. So all you can do is your best every year based on what you do know. Therefore it is a good idea to have a ball park figure to save each year, work towards it and review this amount each and every year and revise accordingly. Again, it’s impossible to predict too far in the future so you just need to do the best you can for the information you know today.

The following link Retirement Portfolio spreadsheet will help determine what you need to save for retirement. Please note that this spreadsheet is intended to be as straight forward as possible. Thus it will not be perfect. For example, what you earn on your portfolio will be different each and every year and inflation may change dramatically. However, it is okay not to be perfect as what is important is that you try and save what you need. As I have mentioned above, a great deal will change between now and the time you retire – all we can do is our best to be in the ballpark. And at least if we are thinking about it and trying to meet our goals, we will be further ahead than if we do nothing or put “our head in the sand” out of fear of knowing. Again, like the other spreadsheets there is one for you to fill in and an example sheet.

Let’s look at an example. Assume a family income is $100,000 each year. After tax they are left with $70,000 of which they spend $60,000 and save $10,000 per year. In retirement they’d like to spend the same $60,000 value. In my experience financial professionals tell you that you’ll need less in retirement. I believe this is wishful thinking as I have never found this to be the true. So in this situation:

(1) It would be ideal to have 3-6 months of spending set aside in a “rainy day” fund. In this case, $15,000-$30,000 held in safe short term investments; and

(2) Then between their RRSPs (Canada) or IRAs/401K (USA), TFSAs (Canada), taxable investments and real estate investments they will need to grow a net worth excluding their home, of approximately a $1.5 million portfolio ($60,000 divided by 4%) based on today’s value.
     a. Note that although I say excluding your home, if you do plan to downside your home in retirement, there may be money from the sale of your home that you do not require for the purchase of your “downsized” home. However, I would be careful on relying on this.

Now let us assume in this example, the family is 10 years from retirement and has saved collectively $1 million so far. Therefore the family needs to save $500,000 over the next 10 years or approximately $50,000 per year (see spreadsheet example) plus inflation. Given that the family’s current savings each year are $10,000 this seems like a bit of a stretch. There are a couple of things this family could think about doing (as opposed to having a panic attack):

1. They can only do their best – so they must stay calm. And ten years is a long time – a great deal can happen over that time. This does demonstrate the point that the sooner you can start to save, the better;

2. When they retire they may decide to downsize their home in which case the amount of money they make on downsizing will contribute to the $500,000 required and reduce the annual savings required;

3. They need to make sure they are including all retirement allowances that they are eligible for when they retire like government pensions and work pensions/similar;

4. They may need to supplement their retirement income with some part time work or consider retiring later than they thought;

5. Perhaps they will need less in retirement then they are spending now; and

6. They must keep their investment strategy appropriate and not try to become too aggressive to make more money through the markets – as luck may have it, there may be a crash around the corner that could squash that plan and make things worse (more on this later).

Once you have determined what you need to save every year in the Retirement spreadsheet, go back to your Budget spreadsheet and see if there are adjustments you need to do to meet your annual savings retirement (or not!).