The easiest way to implement savings and investments into your routine is to set up a pre-authorized contribution – often referred to as a PAC. Begin by looking at monthly cash-flows and determining a comfortable amount to set aside.
A PAC can be set up for most types of accounts – the most common being Registered Retirement Savings Plans, Registered Educated Savings Plans, Tax-Free Savings Accounts and non-registered accounts.
PACs can help individuals reach specific goals, such as retirement, education planning and emergency reserves. If you are unsure of the savings required to reach each one of your goals, complete a financial plan with a list of savings required to meet your goals.
A typical financial plan may recommend that a couple each maximize annual TFSA and RRSP contributions, and save $500 per month in a non-registered savings account.
Dollar-cost averaging is used in finance to explain the purchase of the same investment on more than one day. As an example, if you would like to purchase $20,000 of a particular stock but you feel it may be a bit expensive, one approach is to purchase a half position today at $10,000. If the stock declines then you have the ability to buy $10,000 more without being overweight in the position. By buying the stock on two different dates you are effectively dollar-cost averaging.
If you are contributing every month into a mutual fund then you are buying at different points in the market cycle. For dollar-cost averaging to work it is important to continue contributions even if we are experiencing difficult financial markets.
Financial illustrations demonstrate the benefits of contributing early, even if those contributions are smaller. The compounding effects of investment returns are an important component to consider when developing a savings strategy.
Decision 1: How much can you afford to contribute? Setting aside ten per cent of your monthly income may be a guideline to get some investors started. It is important to look at your financial plan and available cash flows. You can always start with a conservative amount and increase the dollar amount over time.
Decision 2: How often would you like to contribute? Most investors who establish a PAC contribute either once or twice a month. We recommend that individuals consider their cash inflows and match the PAC accordingly.
Decision 3: What type of investment would be most appropriate to set up as a PAC? The three most common options are cash, high interest savings accounts, or a mutual fund.
Typically the people who contribute the amount as cash are looking to purchase individual holdings, once funds accumulate, rather than a mutual fund. Some high interest savings accounts allow investors to set up a PAC. If you choose to do a PAC in a mutual fund it is important to pick a quality fund and review this regularly. Small PACs can turn into a significant nest egg over time if managed correctly. Some fund companies have policies where an initial purchase is required (i.e. $500) to establish a PAC.
Decision 4: What type of an account would you like to set up a PAC for? Many investors choose to PAC for their Registered Retirement Savings Account. If an investor knows their maximum Registered Retirement Savings Plan deduction limit then a PAC can be set up to contribute one twelfth of this amount each month over the year. Another example may be parents or grandparents who want to fund a RESP for a child or grandchild, through a monthly PAC.
One of the main reasons we like PACs is that it sets up forced savings. With the amount automatically coming out of your bank account it also becomes part of a routine that is factored into your cash flows. After a few months, some investors may even forget that they are saving automatically.