Every year, we resolve to lose weight, eat healthy, exercise, quit smoking… you get the idea. And while our health is no doubt important, what about our finances? Below are a few New Year’s resolutions that, simple and obvious as they seem, can truly help improve your finances in 2011.
Do you carry a balance on your credit card or line of credit? Or maybe you have a car loan or some form of financing for furniture? These debts can keep us from doing what we really want to with our money — and paying them off can free up your income and allow you to pursue exactly that.
But paying off debt is easier said than done. Where exactly do you start? One stratetgy is to tackle the debt that has the highest interest rate first. Once that is paid off, move to the next highest interest, and so forth. This way, you’re making more progress by reducing how much of your money goes to paying interest each month. As you get in the habit of paying off your debts, it can be very rewarding to see your balances decline to $0!
Create An Emergency Fund
If you’re debt free, the best way to stay that way is to make a New Year’s resolution to create an emergency fund. Emergency funds mean different things to different people. For some, it’s having enough to cover six months of expenses in case of job loss, for others it might be having enough money to cover car repairs or insurance deductibles.
If you’re just starting to fund an emergency fund, then I think that something is better than nothing. If you can save up $5,000 this year, great. If you can save $10,000, even better.
For U.S. residents, the best place to stash an emergency fund is a high-yield savings account. The rates aren’t really anything to brag with right now, but remember that the purpose of an emergency fund is to save you in case of an emergency — not to make you rich.
If you live in Canada, consider using your TFSA for this so that your income, interest and gains are tax free. You get $5,000 of contribution room each year. If you haven’t contributed to a TFSA before, this means you will be able to save up $15,000. Then if the time comes that you need the money, it’s simple to withdrawal, though you may need to wait until the next year to get that contribution room back.
Save For A Down Payment On A House
If you’ve already accomplished the previous important steps and homeownership is on your To Do list for next year, then you’d have to focus on saving enough for a down payment.
As you are probably well aware, banks in the U.S. now require the good old-fashioned 20% down payment in order to approve most loans. (There are exceptions, of course, but it is safe to say that the more money you can put down, the better your chances of qualifying for a mortgage.)
The minimum down payment in Canada is 5%, though with a high ratio mortgage like this the CMHC requires that you pay insurance that protects the banks from the increased risk they take on. While it might take some time to save, a 20% down payment can be a better goal. This is the amount where you’re no longer required to pay the CMHC insurance and your mortgage payments will be much more manageable.
If you’ve been putting money into an RRSP, meanwhile, one option you should look at is the Home Buyer’s Plan. This allows you to withdraw up to $25,000 (and your spouse can withdraw $25,000 from theirs) towards your first home without being taxed on the withdrawal. Keep in mind that this is basically an interest-free loan to yourself; you need to make equal “payments” over 15 years. This is done by contributing back into your RRSP, but not receiving a second tax deduction on this amount. So if you withdraw $15,000 under the Home Buyer’s Plan, the first $1,000 of RRSP contributions each year will not add anything to your tax refund. This is a great way to put together a down payment, but keep in mind that not having this money invested means you might miss out on future gains.
Maximize Your Retirement Savings
If you live in the U.S., have a 401(k) plan at work and are not yet contributing enough to maximize your employer’s match, be sure to increase your contributions for 2011: that match is as close as you’ll get to free money. And if you qualify for contributing to a Roth or Traditional IRA, you can stash away another $5,000 ($6,000 if you are 50 or older) and, depending on your Adjusted Gross Income and the type of IRA you choose and/ or qualify for, part or all of that contribution may be tax deductible. (Mint’s IRA tool can help you choose the right type for you based on your age, marital status and income.)
Canadians may have a slightly different retirement savings strategy. An average couple might spend $50,000 a year in retirement. The good news is that a retired couple, both of whom worked most of their lives, can expect the Canada Pension Plan (CPP) and the Old Age Security Program (OAS) to pay around $30,000 a year. You’ll hear a lot of different numbers related to how much money you need for retirement, but ultimately the more you can save now, the less you’ll have to worry about it later. (This applies equally to both sides of the Canada-U.S. border.)
Having a well balanced portfolio of low cost index funds in an RRSP is a great way to save for retirement. You can get index funds that cover Canada, the U.S. and international equities. You should also add a bond index fund to reduce the risk. You can simply start with 25% in each index fund, and then rebalance each year. In later years, look to convert some of the equity index funds over to bonds to protect yourself from major losses in the market that you wouldn’t have time to wait for a rebound.
Also consider your TFSA for retirement. Since the RRSP withdrawal is taxed, you can benefit by keeping the withdrawals in a lower tax bracket. Then you can pull extra money out of your TFSA without being taxed on that money. While the TFSA seems rather small right now, someone in their early twenties can expect to have over $200,000 in contribution room before retirement and even more with compound interest and stock market gains over that time.
Pick Your New Year’s Resolution
Those are a few options you could choose, depending on where your personal finances are at right now. But there are many more you could come up with. Personally, mine is to sell off a bunch of stuff I no longer need. This will help provide a bit of extra money, but will also declutter our house and we won’t feel the need to move to a larger house to store even more stuff.
What New Year’s resolution are you making to improve your personal finances?
Tom Drake is the head writer for Canadian Finance Blog, writing about universal topics such as saving, frugality and earning extra income, as well as Canadian specific topics like RRSPs and TFSAs. Tom’s other site is Money Index, which aggregates all the best sites into one easy to use source for everything finance.