At the risk of stating the very obvious, the first step to creating a budget is knowing exactly how much paycheck is left over after taxes and retirement plan contributions, as well as necessary monthly expenditures -- groceries, rent, loan payments, etc. But obvious though it may sound, few people actually sit down and map it all out.
It's a helpful exercise, especially in early career stages when there may not be much discretionary income. Though it's far from easy, the main goal of creating and sticking to a budget should be to find ways to save money instead of owing it. This will ensure that compounding works in your favour and not against you. In other words, compounding is great when it comes to investments -- if you start saving in an RRSP early, the earnings on investments will have decades to compound. It's bad news on the other side of the ledger, though: Loan balances can quickly grow out of control when compounding at high interest rates.
Saving for retirement and staying out of debt is a difficult feat for early career workers, but it's not impossible. Take a look at this example.
Sample budget for an early career worker
According to a study by the Conference Board of Canada, the average starting salary for a university graduate with a bachelor's degree in 2017 was around $54,000. So let's start at the beginning and create a sample budget based on that.
I used this take-home pay calculator to compute approximately how much semimonthly paychecks would be after accounting for federal and provincial taxes, EI and CPP/QPP.
Using Ontario as the province of residence, the semimonthly take-home pay in our example is $1,724 -- or $3,448 per month -- assuming no contributions to an RRSP or company pension plan, and no other payroll deductions for additional employee benefits.
Contribute to an RRSP or company pension plan
But, of course, you'll want to contribute to your RRSP. In these early years, it may seem like there's not enough paycheck to go around, especially with student debt, or when saving for short-term goals like a car or a down payment on a home.
But it may help to think of it in these terms: You'll get the money back years from now, when you may no longer have the ability to work. And even if returns are rather slim, tax-deferred compounding means taking out far more than you put in. If you don't know what to invest in, a target-date fund with a date coinciding with your 65th birthday is often a great option.
When deciding how much to contribute to a plan, determine whether your whether your employer offers a registered pension plan with matching contributions, and aim to contribute at least that much. For example, the company may match up to 5% of your salary; contributing less than 5% means you're turning down money your employer is offering you.
Note that contributing to a company pension plan will reduce the amount you can place in an RRSP. If you still have RRSP contribution room after accounting for your pension contribution and the employer match, you may top up the balance in your RRSP (assuming you can afford to). This article explains contribution limits in more detail.
I factored in 5% of gross pay as an RRSP contribution. If your employer offers a pension plan, you should favour contributing to it rather than to an RRSP, since pension contributions are funded with pre-tax dollars. RRSP contributions are tax-deductible, so at the end of the year the result is the same, but I think having your savings deducted on a pre-tax basis helps with budgeting; if you direct pre-tax money to your pension before it hits your bank account, it simplifies and automates the process of saving.
Food and shelter
The traditional recommendation is not to spend more than 30% of your pre-tax income on housing (which includes rent and utilities). Though rent is expensive and you want to find a safe, nice place to live, I wouldn't go much higher than this, especially if you're basing this number on your pre-tax income.
That's $1,350 per month based on a $54,000 per year salary. According to rentseeker.ca, the cost of a one-bedroom apartment can vary a lot depending on where you live, but in most places $1,350 per month should be more than enough. If you can't find a safe, reasonably priced apartment (for instance, perhaps you live in a very expensive city such as Toronto or Vancouver), there are ways to bring the cost down. Consider getting a roommate, or living at home if your family is amenable and you work near enough.
A squishier line item in the budget is food. Some people are perfectly satisfied spending $200 or less per month on groceries, while others will need to spend twice that amount. Cooking meals at home could help stretch pay, though.
Student loan debt
In Shakespeare's Hamlet, Polonius advised his son Laertes "neither a borrower or a lender be." It's good advice, but I'm betting University didn't cost as much in Denmark in the Middle Ages as it does in Canada nowadays. Joking aside, though, most University grads start their careers with student loans to pay off.
According to a 2015 study by the Canadian University Survey Consortium, about half of Canadian graduates have student debt, with the average balance around $27,000. Let's assume the interest rate is 5%, and the term of the loan is 10 years. The monthly payment would be around $286 per month. Be sure to factor that into your monthly budget.
Set aside money for an emergency fund
An oft-cited rule of thumb in financial planning holds that three to six months of household living expenses should be tucked away in an emergency fund, because if you lose your job it could take you that long to find a new one. But director of personal finance Christine Benz recommends an even larger cushion -- preferably nine months to one year of living expenses, particularly if you are highly paid or work in a highly specialized field, because such jobs can be more difficult to replace.
Try to set aside 10% of take-home pay each month, or as much as you can to fund this safety net.
| Sample budget for an early career worker | ||
| Monthly take-home pay ($54,000 annual salary) | $3,448 | |
| RRSP/Pension contribution (5% of monthly salary) | -$225 | |
| Housing | -$1,350 | |
| Groceries | -$200 | |
| Student Loan Payment | -$286 | |
| Emergency fund (aim for 10% of monthly take-home pay) | -$450 | |
| Monthly income left over | $937 | |
Certainly, there will be other important expenses such as transportation, health and wellness, clothing, entertainment and your phone bill. Here are a few tips for staying on track.
Keep credit card usage in check
Seeing how little cash you actually have to work with every month makes it easier to understand the temptation to rack up credit card balances. Resist the urge! Credit cards offer great convenience -- not only do they save you from lugging around a big wad of cash, they offer a grace period where you don't accrue interest on purchases so you can defer payment until the next billing cycle.
But aim to pay your credit card off every month -- don't carry a balance if you can avoid it. Most basic credit cards charge an annual percentage rate of around 20%, and store cards can charge as much as 30%. Paying off only the minimum balance is not a smart strategy. Minimum payments typically consist of the interest owed plus a nominal amount like $10 or $15. Let's assume you have a $5,000 balance, and you pay the minimum payment every month -- say, $10 plus interest. At a 20% interest rate, it's going to take 41 years and nine months to pay that off -- and when all is said and done you will have paid nearly $21,000 in interest.
Paying for things with a debit card or using actual cash might help with overspending; find a method that works for you.
Keep a spending journal
Write down everything you spend money on for three months. And I mean everything -- morning latte, dry cleaning bill, the album from iTunes. You might be surprised at how much money goes to things that you could probably do without.
On the other hand, this exercise might help identify some items that have relatively small price tags but are very satisfying purchases nonetheless. That, for me, is the perfect intersection.
Do you really need cable?
Try to take stock of monthly recurring charges, and decide which ones are absolutely necessary and which are simply nice to have. Most people consider their cellphone and data plan an essential item, but that doesn't mean you can't shop around to find the best value for money. Cable television can be very costly, and cheaper alternatives abound. Likewise, going to the gym can be great for your health, but not so much for your wallet. If you really prefer the gym to jogging or doing push-ups at home, though, shop smart. Check for a discount through your employer, or comparison shop to see which offers the best value. (Some gyms offer discounts for paying for six months to a year upfront, and others will sell a discounted pass that limits use of the facility to nonpeak times.)
Takeaways
Though it may not be all that much fun, it's valuable to undertake this exercise or one like it. By putting a sharper focus on how much discretionary income you actually have to work with, you will find smart ways to spend your money and keep yourself out of debt.
