5 things you MUST do on your journey to Financial Independence

If you want to get started on your journey to Financial Independence (FI), or if you’ve already started and want to make sure you’re on the right track, then this article is for you.  The purpose of this article is to cover, at a high-level, the 5 key steps that are a MUST on your journey to FI.  In addition, you’ll find links to deeper dives on the key the topics introduced here, so you can get more information on the areas you want to focus on once you’ve completed this overview.

We talk about Hitting Your Beach FASTER on this site, and what we mean by that is achieving FI so that you can be completely in charge of your own destiny.  For some this may mean actually hitting a beach… and there’s nothing wrong with that.  But for many, it could mean doing something new you’ve always wanted to try, or even continuing in your current job but with the knowledge that you are doing so on your own terms. 

Achieving FI is a worthy goal

For me personally, I was fortunate enough to be able to walk away from corporate life in May 2021 after a 23-year career in financial services.  Since then, I’ve been spending more time with family, doing some traveling, riding my motorcycle, managing our investments and rental properties, and building this website. 

I plan to continue learning, and doing, new things. 

Having this flexibility is one of the truly great things about FI.

Believe me, I’ve been there

Wherever you are today in your journey, I’ve most likely been there.  I’ve been at the beginning and felt uncertain if it was even possible.  I made mistakes early on I wish I hadn’t, some that took several years to correct.  And at times further along the path, I’ve come to the realization that there were things I could have done that would have accelerated my journey. 

Sharing this info with you is the whole purpose of this site, and that’s how I hope to help you accelerate your journey to FI.

What achieving FI is really all about

As we go through the 5 steps below, you’ll see that most of the items lean heavily on BEHAVIOURS.  This is the great thing about achieving FI and something that many people don’t quite get.  You don’t have to be a math wiz, an accountant, a brilliant stock picker, or incredibly lucky to become financially independent.  You also don’t need to have a super sized salary. 

You just need to adopt the behaviours outlined here.

Adopting the right behaviours is not that hard, and there are actions you can take to make it easier – and that’s something we’ll talk about below.

So, without further delay, let’s get to it!

#1:  Spend less than you make.  Duh!

It sounds so simple and obvious, but the majority of people struggle with this.  In fact, a recent BDO Canada survey found that 54% of Canadians are living paycheque to paycheque.  At the same time, the amount of credit card debt carried by Canadians is reaching “historically high levels” according to recent data from Equifax Canada. 

All this indicates that spending less than you make can truly be a challenge, so if you’re struggling with this, you’re not alone.

This is one of those key BEHAVIOURS I mentioned earlier.  Simply put, there is no path to building wealth that doesn’t involve the behaviour of spending less than you make.  The good news is, there are ways to make it easier.

Ways to make it easier:

Take advantage of payroll deduction plans.

One of the best ways to save!  The money you choose to allocate to savings comes right off your paycheque and usually goes right into an RRSP, TFSA, or defined contribution pension plan.  It never hits your bank account, so you can’t spend it!

Set up your own automatic saving deduction plan.

If your employer doesn’t offer the payroll deduction option, quite often you can set this up though your bank so that the amount you choose to allocate to savings comes out of your bank account on the day you get paid and goes right into your RRSP or TFSA.

Set up separate savings accounts to cover specific expenses.

Avoid having your savings plan derailed by an unexpected expense.  At the very least, have an account for an emergency fund and one for vacation saving.

Understand what’s coming in, and where it needs to go.

I’ve always said that I’m not a big fan of budgets, but when I look at what I do in practice, I realize that I’ve been budgeting all along.  If you’re like me and have an aversion to the word “budget”, let’s just say that we are getting an understanding of how much money is coming in every month and how it will be distributed between four core buckets:

1. 1. Non-discretionary expenses – food, shelter (rent or mortgage), transportation, electricity, heat, etc.
   2. Paydown of debt – credit cards, non-mortgage loans, car loans, etc.
   3. Saving – RRSP, TFSA, emergency fund, travel fund, etc.
   4. Discretionary expenses – eating out, entertainment, travel, etc.

You can customize this to your liking by having multiple sub-buckets under each of these core buckets.

Bank your raises.

When you get a raise, increase the amount you save by the amount of your raise, rather than allowing your lifestyle expenses to inflate.  It’s ok to celebrate a raise with a special treat but allowing your ongoing lifestyle expenses to inflate along with your salary is unfortunately one of the key derailers of FI plans.

Avoid “compare and despair”, stay away from, or at least limit your time on, social media.

Nothing increases your lifestyle expenses like a couple of hours on Facebook, Instagram, or other social media platforms.  You see all the fun your friends and family are having travelling and going to events, and suddenly you feel you need to do the same just to keep up.  Just remember that you’re not seeing the full version of people’s lives on these platforms.  You’re only seeing the highlight reel.

For many people, this will be the most difficult behaviour to adopt. So, once you’ve done this, or if you already have, you should be proud that you’ve taken a giant step forward on your wealth building journey.

 

#2:  Pay off credit cards and loans.

Once we’re spending less than we earn, this step becomes possible.  Before we get started, though, think about how amazing it will feel to have those credit card and loan balances that have been hanging around for a while paid off.  It will be Awesome!  Removing something like that from your life can be an incredible stress reliever, not to mention a huge improvement in your financial health.

As a first step, take stock of the credit card and non-mortgage loan balances you have, as well as the applicable interest rates and minimum payments.

Next, consider what strategy you’d like to use to get rid of that debt.

Here are two great options:

Snowball Method

With this debt repayment strategy, you tackle the smallest balances first (regardless of the interest rate), while continuing to pay the minimum payments on your other credit card and/or loan balances.  Once you’ve paid off the first balance, you allocate all the payments you were making on that balance to the next larger balance, and so on. 

As the number of target loan balances decreases, the dollar amount of monthly payments that you can direct toward the next target grows… that’s the Snowball effect!

Avalanche Method

With this strategy, you focus on paying off your highest interest rate loans first, while continuing to make the minimum payments on your other balances.  Once the highest interest rate loan is paid, you move on to the next highest interest rate loan, and so on.  As you knock off the higher interest rate loans, more of your payment is going towards paydown of principle, so your total balance is coming down faster and faster – like an Avalanche!

Hybrid Strategy

An alternative approach could be a hybrid strategy, where you knock off some of your smaller balances first to get some momentum going (Snowball), and then focus on your larger higher interest rate balances (Avalanche). 

Both methods work, so pick an approach that works for you and stick with it!

 

#3:  Invest your savings – efficiently!

Now we get into the fun stuff – Investing!  And watching your money grow!

Here we’ll cover the main options for investing at a high-level and go into more detail on each one in future articles.

Option 1:  Speak to a “Financial Advisor” at your Bank

This is one direction many Canadians find themselves going, especially newer investors.  Unfortunately, the term “financial advisor” is used rather loosely by the banks.  A more accurate title would be Financial Product Salesperson or FPS.

These may be pleasant folks, but their goal is not really to assess where you are financially, understand where you want to go, and then help chart a path to get you there.  They’re goal is simply to sell you an investment product.  They have completed the required training so they can legally sell you the product, but they are not legally required to act in your best interests.

Generally, they will offer you some kind of mutual fund which will include stocks or bonds, or a mixture of the two. Unfortunately, these products typically underperform their benchmarks on a net of fees basis.  In fact, according to S&P Global’s annual SPIVA Scorecard, 80%-90% of mutual funds (and in some cases more!) underperform their benchmark.  As an example, the 2021 report found that 96% of Canadian equity mutual funds did not achieve the 5-year returns of the S&P/TSX Composite.

That’s not so good!

Fees you’ll pay:

·         Management Expense Ratio (MER) for Mutual funds are typically around 2% to 2.5%, but some are even higher.

These funds may have a good year occasionally, but it’s really hard for active managers to beat the market on a consistent basis given that they need to offset these relatively high fees with higher returns.

If you’ve already gone this route to invest in your RRSP or TFSA, you’re not alone – I did this myself when I was just starting out.  The good news is you can still move your investment to another option without tax implications.

Option 2:  Go to a “non-bank” Financial Advisor – be careful!

You would think (and probably hope!) that you could avoid the “financial product salesperson” (or FPS) masquerading as a Financial Advisor, by staying away from the big banks.  But unfortunately, this is not the case.  Even within firms that supposedly specialize in providing financial advice and wealth management services, you will often find the FPS lurking. 

If you really feel a need to go with an advisor, you’ll want to find someone who is legally required to act in your best interests.  What you’ll want is a fiduciary. 

But what is a fiduciary?  The Canadian Securities Administration (CSA) defines fiduciary duty as “a duty of a person to act in another person’s best interests”.  This is an important point that many people don’t realize about bank (and many non-bank) financial advisors.  They are not fiduciaries, and therefore they can’t be counted on to act in your best interests.

Equally important, be sure you understand what fees you’ll be paying. 

Fees you’ll pay:

• • The majority of traditional financial advisors charge an annual management fee of around 1% of the value of your portfolio.

• • In addition, there will be fees, or MER’s, associated with the actual investments you hold.

As an example, you could end up paying a 1% management fee plus 2.5% MER on your investments, for a total of 3.5%!  That would work out to $3,500 per year on a portfolio of $100,000. 

Depending on what you’re investing in, going this route could mean giving 25% to 50% of your total returns back to your advisor.  Now that’s expensive!

If you do prefer to go the financial advisor route, be sure to do your research and find someone who will act to the high standards of a fiduciary, and make sure you are getting good value for the higher fees you’ll be paying. 

Or consider the next option.

Option 3:  Utilize a Robo Advisor

Robo advisors provide a great alternative to the traditional financial advisor and big bank advisor.  If you’re not quite ready to dive into DYI investing, or you’re looking for a “hands-off”, and yet efficient, way to manage your investments a robo advisor could be a good fit for you.

How it works

Typically, a robo advisor will have you complete a questionnaire to determine your investing goals and investor profile, including your risk tolerance.  They will then recommend an appropriate portfolio of low-cost Exchange Traded Funds or ETF’s.  You fund your account, set up a pre-authorized contribution plan, and you’re off to the races!

What is an ETF?

An ETF, or exchange traded fund, is a fund that holds a basket of stocks, similar to a mutual fund.  Often, they are structured to track the performance of an index.  For example, there are ETFs that hold the stocks of all companies included in the S&P TSX Composite index, or in the US S&P 500.  Because these funds are not actively managed, they come with much lower fees than mutual funds.  You can easily find index tracking ETF’s with MERs of less than 0.10%… compare that to comparable mutual funds with MERs of 1.7% to 2.5%!

Fees you’ll pay:

For fee information, we’ll look at one of the oldest and largest robo advisors in Canada – Wealthsimple.

• • Management fees – 0.5% for less than $100,000, 0.4% if your portfolio value is $100,000 or more.

• • MER on ETFs – typically in the range of 0.13% to 0.25%

Using the example above, total fees on a portfolio of $100,000 would be:  0.4% + (up to) 0.25% = 0.65% = $650 per year.  As you can see, this represents a significant savings vs. the traditional financial advisor.

Option 4:  Do it Yourself (DIY) Investing

Do it yourself, or DIY, investing is the ultimate investing approach if your goals include minimizing fees and maximizing returns, having greater flexibility in terms of investment options, and having the opportunity to earn above average returns (although, no guarantees on this one).

The DIY approach can be as simple as holding just one or two broadly diversified ETF’s or as complicated as owing a portfolio of individual stocks, fixed income products and ETFs.

Keeping it simple can make a lot of sense.  In fact, billionaire investor Warren Buffett, the “Oracle of Omaha”, has frequently stated that “for most people, the best thing to do is own the S&P 500 index fund.”  By owning an ETF that mirrors the S&P 500, you are owning a fund that includes many of the most innovative, dynamic, and profitable companies in the world. 

And to top it off, these funds tend to have very low MERs often less than 0.10%

As an example, take a look at the Top 10 Holdings of the Vanguard S&P 500 ETF VOO (MER = 0.03%).

 

Many of these names will be familiar to you. That’s one of the great things about owning an ETF on the S&P 500.  With one simple ETF you get instant exposure to the biggest and best companies out there.  You also get diversification given you own 500 companies covering all sectors of the US economy while also avoiding the trap of home country bias that many Canadians fall into. 

You get all of this at the super low cost of 0.03% per year.  As Warren Buffett said, if you own only this one ETF, you’ll do quite well, even better than most professional fund managers over time.

Simple steps for getting started in DIY investing:

1. 1. Open a direct investing, aka discount broker, RRSP, TFSA, or non- registered account.  The big banks all have direct investing brokerages, so that could be a good place to start.  Often these accounts can be opened quickly and easily entirely online, so give it a shot today!
   2. Fund your new direct investing account.  If you’ve opened your account through your main bank, you should be able to easily transfer funds online directly from your bank account into your investing account.
   3. Set up automatic deposits into your investing account.  This will ensure you contribute to your RRSP, TFSA or other investing account on a consistent basis.  Try to set this up so that the money automatically comes out of your bank account on the days you get paid.
   4. Pick one or two low cost diversified ETF’s.  An ETF on the S&P 500 is an excellent option.
   5. Watch your investments grow!  More on this below.

 

#4:  Track & Forecast your Net Worth.

I have always found that one of the most valuable behaviours you can adopt on your journey to financial independence is keeping track of your NET WORTH.  My preference is to do this quarterly, but at the very least this should be done once or twice a year.

But what is net worth? 

Simply put, your net worth is equal to all your assets minus all your liabilities.

NET WORTH = ASSETS – LIABILITIES

What should you include as ASSETS? 

You’ll want to include the current value of any chequing or savings accounts you own as well as investments including RRSPs, TFSAs, RESPs, LIRAs and any non-registered investment accounts.  If you’re investing in an RRSP through your place of work, be sure to include that as well.  If you have a defined benefit pension plan through work, you’d ideally want to include its current value (aka commuted value), although it’s often difficult to get a valuation for that.  You could try contacting the administrator of the pension plan to get a rough estimate.  At the very least, you could sum up your annual contributions and your employer’s contributions as a very rough (and conservative) estimate.

You’ll also want to include an estimate of the market value of your home and any other real estate you own (CAUTION – be conservative when making these estimates). 

Lastly, include the current value of any vehicles you own and any other larger assets.  Keep in mind that you want to value these assets as if you were going to sell yours today in its current state.  For vehicles, there’s a decent calculator at Carfax.ca.  You can also check various marketplaces for used items such as Facebook and Kijiji.  Again, be conservative in your estimates of what these assets are worth.

What should you include as LIABILITES?

Valuing liabilities is pretty straightforward.  Simply include the total balance outstanding on any loans, mortgages, or credit card balances you owe as of the quarter end.  Note that even if you are paying your credit card balance in full each month, if it has a balance as of quarter end, you’ll still want to include that in your list of liabilities.

Again, if you do this exercise quarterly, you’ll be valuing your assets and liabilities as of the last day of March, June, September, and December.

This is your personal Balance Sheet

What you’re creating here is basically your personal Balance Sheet, which is one of the core financial statements that companies use.  If you’ve ever applied for a mortgage, or even a credit card, the bank will ask you for these details on all your assets and liabilities.  They’re essentially building a Balance Sheet for you, so you’ll be ahead of the game if you already have this on hand for your own personal use.

Tracking your Net Worth over time

I recommend tracking your Net Worth in a simple two column spreadsheet in Excel or Google Sheets.  Assets on the left side, Liabilities on the right, and at the bottom calculate your Net Worth.  Trust me, you don’t need to be an expert with spreadsheets to adopt this behaviour.

Doing this quarterly will give you an excellent “bird’s eye view” of your financial situation.  If you happen to have some anxiety about the state of your financial affairs, you’ll be surprised at how calming this exercise can be.  It’s kind of like how creating a “To Do List” can be calming when you have a lot on the go.  And as you track this over time, you’ll have a clear view on if you’re heading in the right direction financially, or if you need to make some adjustments. 

To feel the benefits of this activity as soon as possible, it would be best to go back and build a Balance Sheet for each quarter of the last 1 to 2 years, or at least build a year-end Balance Sheet for each of the prior two years.  Hopefully you can access your old statements online or you have them saved in a folder.  Worst case, you can make some estimates for any numbers you don’t have access to.

Once you’ve adopted this behaviour, you’ll find yourself looking forward to quarter end when you can see the progress you’ve made.  There’s no better feeling!

Forecasting your Net Worth

In addition to tracking your net worth over time, you’ll want to create a forecast of what you expect to happen going forward.  The great thing about having a forecast is that you’ll be able to see where you’re going years, and even decades, down the road.  This can be very motivating and will help you stick with your gameplan even at times when it may seem like you’re barely making progress.

I’ll go into more detail on methods for forecasting your net worth in future articles, but for now, we’ll cover two methods at a high-level.

The “Top-Down” forecast

Using the simplest form of the “top-down” approach, you could apply a conservative estimated annual growth rate to your Beginning of Year Net Worth, plus add in your annual contributions to your savings and investments to arrive at an estimate of your End of Year Net Worth.  Then your End of Year Net Worth, becomes your Beginning of Year Net Worth for the following year, and so on. 

This is a simple approach, but it can be effective in making it clear in your mind that you’re headed in the right direction.  You’ll want to compare your actual results to your forecast annually and adjust your growth rate and your savings contributions as needed.  Word of caution, though, always be conservative in estimating your growth rate and savings/investing contributions.  It’s much better to exceed your forecast most years, then to be constantly feeling like you’re coming up short.