What To Do With My Raise?

What are my options after a raise?

One of the most popular questions regarding personal finance is what to do when you get a raise at work. Everyone likes being told they are getting a raise and seeing a couple extra bucks in your account every paycheck. This seems like a straightforward math question that shouldn’t be too hard to solve, however, there is emotion tied into it because we sometimes have a hard time looking at money without emotions.

This is a good reason to have yourself an investor policy outlining what happens when new money comes in. You have a few options and depending where you are in your journey, you will more than likely lean more heavily towards one option than the other.

Pay Off Your Debt

If you have debt, you should not be going out to treat yourself with a brand new Mercedes or going on an all-inclusive trip to Mexico. I hate to break it to you but until all your debt disappears, these should not be an option to you. I’m just trying to look out for you and help you get ahead instead of always playing from behind.

If you are already in your debt pay down process, there’s good news! You have just found a little extra every paycheck that you can use to further eliminate the debt. If you have $5,000 worth of debt with a minimum payment of $250 bi-weekly, it would normally take you 10 months to pay it off. Let’s say you now earn an $350 bi-weekly. By adding this money from your raise, in turn it will only take 7 months to pay of that debt.

You managed to save yourself 3 months of time. Now not only was your debt paid off in full earlier, but you now have $350 of income that was servicing debt now freed up that you can invest and start generating yourself more future income.

Increase Your Emergency Fund

Some debt already paid off? Perfect! Now there are a few more options at your disposal. Let’s start with the most basic option that we have. Why not save that money and build up your emergency fund if you don’t already have one? It’s definitely not the sexy choice but it does have the most calming affect for you as it will allow you to sleep better knowing that you have a healthy and sizeable emergency fund saved up. I like to have approximately 4 months’ worth of expenses saved. I’d also recommend keeping it liquid, making it readily available if you need cash fast.  

The further down your journey and the more streams of income you have, the less reliant you will be on your emergency fund. Why? Because if you have other sources of income coming in (Side hustles, Cash Flow from rentals, Dividend payments, etc.) you will have other sources available to you to replenish it quickly or mitigate the need of a larger fund.

Increase Your Mortgage Payments

You have no debt other than your mortgage payments on your house? Why not try to cut that down as quickly as you can. Let’s say you have a house with $300,000 remaining on the mortgage for another 25 years at 2.14%. That monthly payment equates to roughly $1,291 that you are paying towards your principal on your house. That is also the base number required to service your mortgage. Now, if you add the extra money that you have from your raise on top of this, you will be able to accelerate your payments and chop off some time.

Topping up your payments will not only help you in the long run of making your mortgage disappear quicker, but when it comes time to refinance your house down the road and rates go back up (rates will not stay this low forever) you will have more wiggle room because you had already paid off a larger chunk as you were going. Now you will be able to stay closer to your base payment as rates go back up. On top of this, you will be paying less in interest at the same time as having paid off the house faster. This results in less money you are giving to the bank and more money in your pocket.

By increasing your mortgage by $200 a month you can save yourself $15,703 in interest. You also paid off your mortgage 4 years sooner, bringing your total amortization time down to 21 years.

Depending on your stage in life, there are some drawbacks to paying down your mortgage faster. If you are in the younger demographic, making the extra payments on your mortgage are nice because you are freeing yourself up quicker, however you could possibly be missing out on some larger returns in the market if you were to invest it (we will touch on that shortly). If you are in the older demographic, your house is probably your last remaining piece of debt keeping you tied to your job. Having this mortgage taken off your ledger will allow you to live completely debt free, with no major bills due.

Increase Your Investments

For some people that math is quite simple. Let’s say you save that that $100, invest it, and get an annual return of 8%. With a 2.14% mortgage (current rates at the writing of this post), the math would tell you that you have a greater advantage investing it and getting the net positive ~6% annual return rather then paying off the low interest debt.

Looking at it quickly, you will be hard pressed to find people who don’t believe the market will be higher in the next 25 years than it is today. The gap of 6% a year compounded over 25 years can quickly add up to a large sum of money. In this case, it adds up to just shy of $140,000 you would have on its own if it was invested. That’s a lot of money for just topping up your investments by the amount of your raise and letting that ride.

If you are tacking this extra $100 on top of our other investments, you are going to be accelerating your investment growth by consistently adding more money into the market for long term growth.  

Here is the real kicker with this option: it really depends what your relationship is with money. For some people, the math tells them that it’s a better utilization of their money to invest it and get the surplus return, however, there is something magical about watching the amount that you have remaining on your mortgage get chipped away faster than expected.

This almost seems like a trivial issue that would be easy to decide between, but sometimes our emotions get in the way and block our judgement. It’s nice to have a guideline to fall back on that would help us figure out the best way to deploy our money. Both options have their own benefits that can help you further down the road. 

What I Do

Personally, I do a little bit of both. I have my baseline lifestyle that I live at which is very similar to what it was when I started working. I take every raise I receive and I put it towards making extra payments towards my mortgage with the intention of using some of the equity in my property to purchase a rental property. I did this for 4 years prior to refinancing my property.

Now I still pay a little extra towards my mortgage because I like round numbers, but the rest of it has been shifted to going straight into investments. I find this an effective strategy because I’m putting my money to its highest and most effective use. If I were to let that money come into my account every paycheck I would easily find a way to spend it. Money without a job will find its way to spend itself every single time.

This is what I am comfortable doing because I understand the time-value of money and the faster that I deploy it in the market the better chance I have to make it grow faster in index funds. At the same time, I like putting that little bit extra down on my mortgage bi-weekly to see my mortgage shrink even a little quicker.

The Power of the TFSA

Going to need a bigger piggy bank

The Tax-Free Savings Account can be one of the most powerful tools that a Canadian can have right now. When most people turn 18 they would rather take a quick jump, skip and a hop to Quebec to have their first legal beer. While this does sound pretty good, there is one thing you should do before you go indulge yourself in liquid courage. The day you turn 18 you should open your TFSA, the spot you want to begin your investing journey. Even if you open it and just fund it with a little seed money to get your feet wet, you’ll be thankful in the long run.

You can also set up automatic deposits that you can transfer the money right into your TFSA off your paychecks so you never even see it. This allows you to remove the temptation of spending all of your money immediately when it comes in. Trust me, you will thank yourself in the future if you do this. If you have enough discipline to do it yourself, all the power to you! There is a limit that you will have on the amount that you will be able to contribute to your TFSA. If you turn 18 in 2020, your contribution limit as soon as you open it will be $6,000. Now most people won’t be able to fill that up right away but that’s okay, just begin funding it. Once you build it into your system you’ll be good to go. As every year goes by, you will collect more contribution room

Now that you put some money in there, you are probably wondering that’s great, now what? First thing I would recommend is to do a little research and don’t take the advice of the bank advisors that help you open your TFSA. Why? I have helped numerous people open their TFSA over the years and at multiple different institutions, the first they do is try to sell you their in house actively managed mutual funds. The reason they do this is twofold:

  1. They already have your money so why not keep it in house and let them actively try to manage it and get you the returns they are promising. The funny thing with that is that normally those funds are heavily loaded with management fees that will chew into your returns very quickly. Why are the fees higher on them? Baked into the price you have to cover the costs of their buildings, staffing, overhead and a lot of other smaller things. Unless they give you a ridiculously low fee, there’s probably a better option for you. So just politely decline and do some of your own research.
  • Not only will the fees eat into your returns, but do the fund manager’s actually care about you? Regardless if the fund goes up 5% or down 5%, they are guaranteed to get their cut of the pie regardless, just for managing your money. I’m not saying that all mutual funds are bad, I think some of them are great, but you need to do a little research and determine what your own investor’s policy is and what fits into your plan long term.
I can only imagine this is what they do when they collect their fee

There are a couple different avenues you can go into from her:

  • You can buy an index fund and get a collection of multiple stocks inside of a basket that will generate a dividend, which in turn, can result in a dividend reinvestment plan.
  • You can buy a single stock that you believe is a solid company, maybe one you use on a nearly daily basis, such as your internet provider, utility companies or cell phone providers. Collect their dividends and let that pay for part of the bills you pay to them..
  • You can invest in a company that you feel strongly about that has some growth potential, maybe one that you feel is undervalued.

Single Stock Investment

You have plenty of options here at your disposal. $6,000 worth of contribution room in your first year gives you more options than you think over time. Let’s say you invest this in your internet provider because you want to chip away at your internet bill a bit. If you leave that money invested with that company, you can get your share count to grow if your dividend payment is large enough to Drip you one extra share per dividend distribution. This can definitely add up to some good payments down the road.

Let’s say you use your initial investment to invest into your internet provider, at a price of $60 per share. Investing the entire contribution amount ($6,000) will give you 100 shares in the company. Now imagine this company produces a 5% dividend yield. That’s $75 per quarter ($300 per year) you can collect for just holding your internet service provider. You can pull that $75 per quarter out every time and use that to pay down your bills.

Not bad if you ask me. Also, whatever amount you withdraw can then be recontributed the following year! So, if you withdraw that $300 the first year and the contribution limit is consistent, you can contribute $6,300 the following year! While it’s not going to take care of your entire bill for the year, it can go a long way towards contributing towards your future growth

Now what if you left your shares in there? If you let the shares keep reinvesting for 30 years with a 7% growth of the stock including the dividend reinvestment you are looking at turning your original $6,000 into $180,000 that produces you $8,000 in annual income (more than your original contribution amount) with the dividend increasing to stay consistent with 5% yield. That’s just one stock that you hold for 30 years; now imagine every year with your new contribution room you buy another, followed by another one the year after that and so on and so forth. Here’s the real beauty of it all; it is tax free when you withdraw it in the future. All you did was turn $6,000 into 30x the money in 30 years! That is absolutely mind boggling! The downside with this is that you are possibly leaving yourself exposed to the volatility of having all of your shares in one basket.

Index Fund Investment

Maybe you don’t want to only invest in one individual stock because it’s too volatile and you don’t have quite the same risk tolerance, so instead you invest in an index fund that covers the entire Canadian market. (For this example we will use VCN, the Vanguard All Cap Index ETF VCN). This index matches the market value of the top 188 companies in Canada. The dividend yield on this is lower, however, with it being lower you have lower risk of volatility because you have a large basket of companies. Borrowing some information from the example above, let’s say we contribute the full $6,000 initial contribution into VCN which returns with a dividend yield of 2.8% (at the time of writing). You will start 181 shares, producing about $42 per quarter or $168 per year if you don’t reinvest it. This isn’t as fantastic as owning the individual stock but you have significantly reduced your chances at a large swing in volatility because you own 188 instead of 1.

Now, what if you were investing all of your dividend payments back into the index every quarter as you went along. Again, we will use the same metric as before, using 7% return per year over a 30-year time period. This turns your original $6,000 into $99,000, which multiplied your money sixteen-fold. Now the numbers definitely aren’t as explosive as the single stock investment that was given above but there’s major takeaways from this. You didn’t have to do a whole lot of research to determine which stock to invest in, as you invested in the market as a whole. As it grows you are buying more and more of the entire market, not just a single investment. You still did very well considering you turned your original investment into almost $100,000 for saving a little money and investing it for the long term.

If you were to start this the day you turned 18 and invested your $6,000 you would have that money by the time you are 48. If you would like to have fun, go play around with your numbers a bit and see what type of crazy returns you can get if you were to start early and let time do the heavy lifting for you. That should be your main takeaway here. For the TFSA, if you start early and let time work its magic, you should be able to produce large sums of money that will come out tax free when you withdraw it. Sounds like a pretty easy system to implement to give yourself a nice little chunk of change in the future.

What is FIRE and how do we retire early?

Make life what you want it to be. Photo taken by my buddy Ian.

Imagine you are 45 years old waking up and not having to go to work. You get to wake up and pursue your passions, go to the gym, go golfing or travel and never have to worry about work, deadlines or money again. That sounds like quite the dream. Many people can do this even faster than 45; some have done it before they have even turned 30! It’s rare but this does happen.

For others, maybe not so much. Some people have a tough time imagining themselves retiring before the standard age. Maybe it’s because they didn’t save enough earlier or maybe because this is the way everyone was taught. Get a job, work for 35-50 years and then you get a few years down the road to enjoy the fruits of your labor. Though there is nothing wrong with that if that’s what you want to do.

However, there is an entire community out there of people who come from all different backgrounds, ethnicities, genders, professions and from all different walks of life that have managed to escape the rat race of the 9-5, Monday-Friday grinding slog of work and only living for the weekends. It’s scary to think that there is a way to avoid this from an early age. These people are known as the Financially Independent Retire Early community or FIRE for short. They are people who live like no one else now, so that they can live like no one else later in life.

Quite honestly, it’s not for everyone and it does take some self-commitment, short term sacrifice and living slightly different than everyone else. I’m not saying that they all eat beans and rice every meal, they just choose the things that matter to them in their life and don’t try to keep up with the Jones’s because little do people know, the Jones’s are broke. Who are the Joneses? They are the new neighbors down the street that just bought the biggest house on the block. They lease the brand new Mercedes SUV, take the $5,000 trip to Mexico every year, she buys the new Gucci handbag, and he looks like a Ralph Lauren polo model on his way to the country club, while having their house and lawn professionally taken care of. On the surface that life style probably sounds amazing! However, odds are most of it is financed with credit cards that are leveraged to the hill, a paycheck that barely stretches far enough to cover all of the bills, massively crippling car payments and one emergency from having their house look like Buckingham Palace to looking like a shack in the bayou . Doesn’t sound too great anymore does it?

For those who are looking to change up their ways a bit and don’t want to retire early, they probably fall more into the category of Financial Independence, Refocused Energy. The latter is probably a better use of the acronym because it seems that people spend so much time wanting to not be at work that when they are able to retire either early or not, they in turn focus their energy on new things. Whether that be travel, running their own small business, catch a serious golf addiction or whatever it may be, as long as it makes you happy and you are passionate about it, then pursue whatever you want.

Personally I’m looking more towards securing myself with a FI lifestyle rather than a FIRE lifestyle right now because I love my job and at this point in time there are further places I want to progress to in my career. One day, I may like to be able to pull the plug early and pursue things that interest me more. For right now though, I am content building up my career, my passions and my portfolio.

There are multiple stages of FI listed by various bloggers and financial gurus. All of them have the same end goal: being able to pursue your own passions and dreams without having to worry about money. But their difference lies in the paths that they take to get there. Some believe the best way to get there is to never have debt, pay off the house as fast as you can, don’t use credit cards and only buy investments once you have reached a position of 0 debt, regardless if it’s good or bad debt. Others believe that you can use good debt to your advantage and help build up your portfolio as long as you are doing it responsibly, while some build a six figure business on something that they are passionate about and eventually sell it down the road. As you can see there are many ways to get to where you want to go; you just have to choose the path that suits you best. No one will be able to tell you what will work for you. Everyone has their own story and philosophy on what works for them but ultimately it is up to you to design the life that you want to pursue.

You to determine what your priorities are and fine tune your plan to meet your criteria and that way you have an idea where to start. That is one of the truly amazing things about the personal finance community. It’s not the numbers that people throw out there. It’s about the stories of how people got to where they are now, the struggles they had to go through and overcome, the curveballs that were thrown their way and how they hit them out of the park. Everyone has their own perspective and story to tell.

Here’s a key take away from this that I think people need to understand. You don’t try to pursue this lifestyle because you hate your job and you want out of it. Maybe you do hate your job and you want out, you grind so hard gutting it out for years saving money and investing waiting for the day to get out of the rat race. Finally that day comes and the weight is lifted off of your shoulder from your last day at work and you are satisfied. Next day rolls around, you are just roaming around the house trying to figure out what to do. Next thing you know a month goes by and you are looking to go back to work. Why? Because you never built a life style that you wanted, you spent so long running away from your job that once you got away from it, you had no idea what to do.

Before you figure out what your FI number is going to be, you need to think of the life you are planning on living. Look around at your current lifestyle and ask yourself, would you like to be able to sustain this lifestyle in the future and in retirement? Maybe you want to have more luxuries or possibly have a different lifestyle. Here are some things you might want to consider. Where are you living? Are you living in the same house you are now or maybe you decided to do some geo-arbitrage and just travel around the world living in a few different countries for a few months at a time? What are your passions and hobbies? Do you enjoy wood working and making tables and chairs or do you have a passion project restoring an old Camaro in your garage? Or would you like to travel around the country and visit all the small villages and take in what you can? Depending on how you view your life post working career it could affect your numbers in a fairly drastic way.

Sounds nice right, but how do we find out how much we will need? First you need to determine your current expense for the year, if you aren’t sure, go back and look. If you think you will be able to survive on 40k a year with no debt and a fully paid off house in the future the number is pretty easy to get to. Your FIRE number is 25x your yearly expenses, in this case, the number is $1,000,000.

Using the 4% rule of thumb is a guideline that when you hit your FI number, you will be able to draw down a small portion of your portfolio every year that will let you live off of it and not have to work again. Some people won’t need 4%, some will need more and some will need less depending on market cycles and economies. If you go to FireCalc.com and run a few simulations on how long your money will last. Using the $1,000,000 listed above with a 4% withdraw rate, there is 95% chance you will have enough money. Not only that, the average of the portfolio that you would have is still 80% higher then what you had originally targeted.

Simulation was ran with a 30 year time frame.

Worse case, if you start drawing down on your portfolio too fast, you have a few options to fix it. You can either start to spend less, curb your spending or worse case you go back to work for a bit. Really though is it that bad? As Joel from FI180 said “your worst case scenario of going back to work, is everyone else’s normal life”. Now it really doesn’t seem that bad, does it?

Now a million seems like a long way away, and it might be for some people, but to get to a million, you need to get to $100,000. From there you had to get to $10,000, from there, $1,000 and before there, you had to start. There are multiple different levels of FI but all of them tend to start at the same place.

Every journey begins with the first step. If you aren’t sure of what maybe you would like or what you want your life to look like. Take a few minutes maybe and consider things you would want in your post retirement life. From here the journey can really start to begin.

Removal of Debt

The first step is to remove all of your high interest debt from your life. Mortgage rates are so low right now that you can leave this part out of the equation, but there will be a future post tied if it’s a good move for you to pay down your mortgage.

Debt that needs to be paid off includes but is not limited to; credit card debt, student loan, car loans and the list goes on. Anything that isn’t mortgage debt needs to be cleared because that does nothing but tie you down tied to your 9-5 as you need to have the money coming in to pay those bills. Not eliminating this debt keeps you stuck in neutral on this journey because you won’t be able to start moving forward building wealth if you are always paying down debt.

Emergency Fund

Once you have all of those paid off, then comes the tedious, but arguably most crucial, part of this entire journey. Funding your emergency reserves. You need to build a reserve fund that you can use to weather through the storms for when they come, because they do. Your furnace goes out in the middle of the night? Use the emergency fund. Car needs to go to the shop for a $1,500 bill to fix your breaks? Use the emergency fund. Want to go on that trip down to Mexico for a week for $1,200? Do not use the emergency fund for that. That is not an emergency, that’s an excuse to use this pile of cash you saved up. This is not the purpose of it. When you pull from your emergency fund, you must replace it ASAP. Watch how well you start sleeping knowing you have some emergency money socked away.

Your emergency fund should be able to sustain your basic needs for a few months. Everyone has their own rule of thumb for how big it needs to be. Some people have it at three months of expenses, while others have increased it to a year’s worth. Your situation is going to be different than others as it is based on your expenses, lifestyle and stream(s) of income.

Building and growing investments

After that the real fun starts. Use the amount that you were putting aside for your emergency fund and start sticking that money into your investment accounts and get that growing. It doesn’t matter if its $200 or $2,000 a month, get that money working for you. The earlier you start getting that money working for you in the market, the more wealth you are likely to accumulate.

At this point you have crossed the 1km mark of a 15km race. It’s not necessarily about how fast you want to finish the race. It’s the consistency of your pace that works for you. Keep the amount you are putting in there consistent and if you can increase the number, increase it but constantly be putting something into your investment accounts. You are going to get there as long as you build yourself an investment system and stick to it. If you can funnel more at the start of your journey you can ease off a little on the back end and enjoy life a little more but the point is that you need to get started as early as possible because you owe it to yourself to live the life of your dreams.