Saving is one of the most important aspects of budgeting. Here's a simple and efficient method to save and be ready for the unexpected: the Three-drawer Strategy.
Once you've paid off expenses like your mega store cards and credit cards, it's time to take a systematic approach to money, in three drawers. What goes in each one?
Drawer #1: The emergency fund
This drawer is by far the most important. It's filled with the emergency fund. It's filled to cover at least three months of expenses. In case of sickness, an accident, or other loss of revenue, this is where you'll find the cash to cover expenses. If you are self-employed or have temporary work, six months would be more prudent.
Let's make this clear! This is not an investment, it's liquidity. A bank account with no minimum charge or penalties will do nicely as a drawer for this money. An online bank account is also good. Remember that amounts up to $100 000 of your bank balance are protected by the Canadian Deposit Insurance Corporation.
Drawer #2: For projects
The second drawer is dedicated to projects. For example:
- Transforming the basement into a home theatre, buying a second car, a down payment for a cottage (ah the country!) or for a European vacation.
- While saving for medium-term projects, you can collect interest, or get a tax free savings account. Don't just keep one bank account. Your dreams are worth more. And you are too!
- A prudent reserve of savings or strategic portfolio will do the job. When you save for a period of 3 to 5 years, you can expect an average annual interest return of 3 to 5%. All RESP investment products are also tax-free. There are also stocks, bonds, funds, options and tax free savings accounts. The more you contribute, the sooner you will make your dreams come true.
Drawer #3: For retirement
The last drawer is constantly needing to be filled because we empty it regularly for the leaky roof, or because our youngest child is going to university. The first two drawers are for unexpected costs. This one is for the long term.
This is the drawer for retirement. It's perfect for keeping your RRSP savings and employer pension funds. It'll be often neglected, because we don't like to think about the future. Still, the choices we make today will have a big influence on our quality of life when we reach semi-retirement and retirement age. To better calculate the future, you can use a tool like SimuR by the QPP or ask one of our brokers. Happy planning!