Its amazing where one might draw an inspiration for writing. This morning, I was looking out through my window into the back garden, as I often am, watching the squirrels scurry about. A grey runs by with a nut, a black is digging in a garden bed, another grey is chased by a red, and then all of a sudden, the red is chasing away the black one. The one thing I will say about squirrels at this time of the year is that they are scattering around everywhere with an abundant energy level gathering food for winter.
Squirrels are very cautious creatures, but they are not timid. If you have food, even a wild squirrel will come right up to you. They are confidently cautious, a perfect balance. But, there’s something else that I like about squirrels, and that is their ability to store food. I watched the grey squirrel as he came from a neighbour’s yard with something quite large in his mouth. It was honestly the size of its own head. He ran across the fence, then down, then started burying it with his little hands and then pounced on it for safe keeping. Ran back, got another huge chunk of something, and went into a different part of our yard.
This squirrel was taking large chunks of food and hiding them, squirrelling them away, if you will, but not all in one spot, no; they were being placed all around my yard. It dawned on me how brilliant he was. Not only was he storing up large quantities of food for later, while it is plentiful now and not so in the winter, but he was not storing all his food in one place. Lastly, this squirrel was working hard. Going up and down and along the fence, gathering, finding hiding places, storing. He was truly working. There are many things we can learn from squirrels.
I was intrigued with this squirrel’s behaviour. In my initial research, I came across a fascinating fact. In 1985, Franco Modigliani, an economics professor at MIT, actually won the Nobel Prize for a simple technique that squirrels know intuitively from birth. You have to squirrel away some nuts during times of plenty, so you can survive during times of scarcity. This has direct application to financial life planning concepts.
Modigliani looked at the income and expenses of typical people over the life span. He found that household income was sometimes more than sufficient to meet expenses and that at other times money was tight. Preparation during these times of surplus help families avoid going into debt when they must increase their spending.
Modigliani divided the life cycle into four distinct phases:
- Before having children, there is often a surplus of income.
- While raising and educating children, there is often a deficit when the family is spending more than they are earning.
- When children go out on their own, families often have a surplus again.
- In retirement the surplus is small if it is there at all.
Saving during the two surplus periods is crucial to financial well-being later in life. Before the children arrive, squirrel away some money. When the children leave home, you get one last chance to save for retirement.
Here are seven financial life planning lessons I derived from Modigliani’s analysis:
Don’t duplicate your parents at the start
Most of today’s college graduates are ill prepared for the real world of financial responsibility. They never saw how their parents lived when they were first married and struggling. Consequently, they may base their after-school expectations on an upper-middle-class lifestyle.
If you are a young adult, you can’t afford more house than your budget will allow. If you spend 50% of your lifestyle expenses on housing, you will not be able to live proportionally on the rest of your income. Too much house is one of the most common mistakes young people make.
It is as though we can’t feel successful without immediately enjoying the lifestyle of our parents at the height of their careers. To decide how much house is enough, calculate what you can buy for 30% of your standard of living.
Save strongly in your twenties
Early in your career, when the cost of basic needs is small, income often easily covers expenses, allowing the surplus to be used for savings, investment or added consumption. Many young people assume they are doing so well financially that they can simply spend their extra money on more stuff. They do not realize these years of plenty won’t last.
During this period, try to save and invest up to 50% of your disposable income for future expenses. Fully fund your individual and group RRSPs (to take advantage of any employer match). Save 10% of your take-home pay for future large expenses. Put an additional 5 to 10% into your TFSA subject to the maximum contribution available and the rest to long-term savings.
This advice is especially important for those who delay marriage until they are in their 30s. Don’t waster a decade of prime saving and investing time. You owe it to yourself and your future family to store up nuts now.
Don’t just save, invest
You can’t afford to keep your money in cash or in a bank account earning very little interest because of inflation. If you had saved $100 in 1970, it would only have the buying power of $17 today. You need to earn a return that exceeds inflation. Fortunately, you can.
At 10% market returns, whatever you save and invest doubles every seven years. That is referred to as the “rule of seven.” Google it. As they say on The Big Bang Theory, let’s do the math. Every $1 saved and invested at age 21 doubles eight times before age 70. At that rate of return $1 saved and invested grows to $128 in retirement. If you wait until age 49 to start, $1 saved and invested will double three times, growing to $8.
Although annual volatility is high, it decreases with a longer time horizon. Given a 50-year time horizon, the odds of your money experiencing a positive average market return are very good. Or put another way, for every seven years you delay starting to save and invest, you risk cutting in half your net worth in retirement.
Avoid debt while raising a family
I know this is easier said then done. Expenses certainly multiply once children arrive. The one-bedroom apartment is replaced by a three bedroom home with a mortgage. If expenses for food, clothing, medical, dental, clubs, camps and lessons aren’t enough, children have their own set of endless desires. The average cost of raising a child to age 18 in 2017 dollars totals about $245,000. Then, after this, the balloon payment comes at the end when post-secondary expenses are often financed through student loans and additional mortgages. During these years, many couples wish they had not spent their pre-child surplus.
Families find it challenging to live within their means during this phase of life. But you can live more simply in order to live debt free. The actual difference between middle income and multi-millionaire is a few hundred dollars a month in saving and investing.
Stop saying you’ll get your finances in order later
The average Canadian family runs their financial affairs in such a way that if they were a publicly traded company, their stock price would plummet, the business would go bankrupt and the people in the accounting department would be arrested. I know that is a little far fetched but the point still rings true for a lot of families. You can’t postpone financial faithfulness. Your habits set your financial DNA, and habits are simply habit forming.
Many people mistakenly believe that life comes in three stages: learning, working and recreation. They think that until they are toward the middle or end of the working stage of life, they don’t need to worry about finances. Everyone in Canada can save something. Whatever you save, the magic of compound interest produces incredible results. It is far preferable to know what you need to save than to arrive at retirement unprepared.
Get a retirement checkup before age 50
For most families, expenses drop significantly after children leave home. At least that’s the plan. Although starting younger is ideal, these are the years when many families realize time is running out to prepare for their retirement and they seek professional financial advice. This period provides a second chance to save and secure a financially comfortable retirement.
If you are in this stage of life, you need to know exactly how much you must save to achieve a comfortable retirement. You don’t have the luxury of guessing at the appropriate savings rate.
Know your safe withdrawal rate in retirement
Retirement ideally finds the family with income adequate to continue their usual lifestyle. With sufficient assets and good asset management, income from savings and investments, pensions and benefits should cover retirement expenses.
During retirement it is crucial to know what rate of withdrawal is safe. Spend too much and you will run out of money. Be too frugal and you needlessly put a damper on the years you might be traveling and gifting. You must have the right asset allocation to provide enough growth for a long and prosperous retirement but enough stability to weather market upheavals. This is another juncture that does not allow for guesswork.
The lessons to learn from this are simple: Before the children arrive, squirrel away some money. When the children go out on their own you get one last chance to save for retirement. Much like the frantic squirrel activity we see at this time of year, we realize that the squirrels only have a short time to amass their winter food supply before hibernating. In life, we only have a certain amount of time to save for our futures, and the future of our families, so starting early and spending wisely is important and necessary in Keeping Life Current.