Canadian Investment Accounts: Which One to Start With?
Investing your money wisely is essential for achieving your financial goals. One of the best ways to do this is by following a strict order when allocating your funds. This order is often referred to as the "order of operations" for investing and it is crucial for maximizing your returns while minimizing your risk.
The typical order of operations for investing for a young Canadian is as follows:
Emergency fund: The first step in investing is to establish an emergency fund (e-fund). This is a savings account that you can use to cover unexpected expenses such as medical bills, car repairs, or job loss. The normal guidelines is to have at least 3-6 months of living expenses saved up in this account before moving on to other investments. This amount will depend on many factors (job security, how quickly you can get a new job, do you have more or less support from friends and family, personal risk tolerance, etc.). If you’re just starting getting $1,000 in an emergency fund can be a good first goal.
TFSA: A Tax-Free Savings Account (TFSA) is a great place to invest your money. The contributions you make to a TFSA are not tax-deductible, but any investment income earned within the account is tax-free. This means you can earn more money over time, and you won't have to pay taxes on the gains when you withdraw your money. Roughly $6,000/yr once you turn 18 (only in affect after 2009).
RRSP: A Registered Retirement Savings Plan (RRSP) is another great investment option. Contributions to an RRSP are tax-deductible and the investment income earned within the account is tax-deferred. This means you'll pay taxes on the money when you withdraw it, but at that point you'll likely be in a lower tax bracket than you are now.
Brokerage Accounts: Brokerage accounts are investment accounts that allow you to buy and sell stocks, bonds, and other securities. These accounts can be a great way to diversify your portfolio and earn higher returns than you would with a savings account or money market fund.
This the the typical order most people would recommend. However I would recommend considering a new account before moving to #4, the brokerage account.
3½. Bucket List Sinking Fund: A sinking fund is a type of savings account or investment vehicle that is set up to save money over time to spend for a specific purpose. We want to use one for bucket list items. I believe allocating a certain amount of month every month towards to save up for a bucket list item make the journey more enjoyable. This can anything from Skydiving, to Hiking Machu Picchu, to spending a month in Tokyo. The important part is that you can see the money slowly accumulate over time and can enjoy dreaming about the fun experiences it will afford.
Here’s an example of how all this could work:
Sarah (female): Turns 29 year in 2023, born 1994.
Earns $3,000 per month take home.
Expenses excluding investments are $2,000/month.
She has $1,000 saved in her emergency fund (Her target is $6,000)
$0 in Investments
Option 1:
She could focus 100% on fully funding her Emergency fund, which would take roughly 5 months ($1,000/month saving)
Then she could move to her TFSA investing $1,000/month (into index funds). Since Sarah is 25, she has $57,000 contribution room in 2023 in her TFSA (7 years worth). This would take 14 years to max out assuming she never increasing her monthly investments more than $1,000/month. She would max her TFSA in 2037, investing over $164k. However this is unlikely as someone goes through their careers and sees their incomes grow). If she increases her investments to $1,500/month it would be maxed in 7-10 years.
After maxing out her TFSA, move to RRSP. Focus on maxing out the RRSP which can be up to $30,780 for 2023. If you have a few year of RRSP contribution room to catch up with, this could take a while, if ever. That’s okay, it is a lot to invest, especially early on in our careers. As our income grows it will get easier to invest more (if we built our investing habit early).
If Sarah manages to max our her RRSP she could move to her Brokerage account. This would only make sense if she had a lot of left over income, and her goal was to retire as quickly as possible.
Eventually Sarah will have enough investments to retire, and finally do those things she’s been wanting to do her whole life. Hopefully she has the health and energy to do them.
If it wasn’t obvious yet, I’m not a fan of this option. I prefer a more balanced approach.
Option 2:
Depending on personal risk tolerance, could slowly fund her Emergency fund, $500/month which would take roughly 10 months ($1,000/month saving) to get to that $6,000 total.
While she’s funding her e-fund she could start investing $300/month into her TFSA investing (still using index funds). Once she’s done funding her e-fund she can increase this to $800/month. This would take her roughly from 25 years to max out her TFSA (assuming everything else stayed the same $6,500/yr limit increase, $800/month invested).
That leaves $200/month, and I would use that for her Bucket List Sinking Fund. This would give her $2,400/year to create one amazing experience she’ll remember for the rest of her life. The added benefit of this approach is that you have something to look forward to while saving and investing for retirement. It might mean extending the time it takes to retire, but it gives you one amazing.
During her career Sarah’s income will fluctuate but hopefully trend upward as she develops her career and accumulates experience. As her income grows she may start gets into a higher tax brackets and start to consider investing more into an RRSP on top of her monthly TFSA contributions.
If Sarah never increases her investing more than $800 per month, she would max out her TFSA in 2048, investing $243,000. And by 65 would be forecasted to have over $2,000,000 Here’s a calculator I made to figure that out: HERE.
If Sarah manages to max out her RRSP she could move to her Brokerage account if she wants to continue working and accumulate a larger portfolio before retiring (also known as Fat FIRE) this would be her remaining option.
By following this order of operations, you can ensure that you are investing your money in the most efficient way possible. It's important to remember that investment goals and strategies will change over time, so it's important to review your portfolio and make adjustments as needed.
