You’ve finished your education, started your career, and are enjoying the regular paycheque that’s coming in. But you also want to start planning for your financial future. So where do you start?

The simplest answer is to start budgeting and understand your net worth—which is the value of all your assets, minus the total of all your liabilities. And your biggest asset right now? It’s actually you — along with your knowledge and education, also known as human capital. Your human capital translates into economic value for your employer and earning power for you. For instance, you may have already invested in your human capital through post-secondary education. And you can increase it even further with more training, education, and by pursuing interests outside your core area of expertise, such as volunteering or publishing your writing. Learning new skills can further increase your earning power and protect it in the event of a downturn in your chosen field of work. 

Your earning potential

Consider a new grad, with a starting annual salary of $55,000 in 2022. If we assume average wage growth of 2.4%¹ per year from 24 to 60, a new grad could potentially earn over $3,200,000 in pre-tax income over that time span even before accounting for any promotional opportunities that may increase earning power.

The trick becomes how to turn all that earning power into investment capital you can use to meet your financial goals, which may include paying down student debt, purchasing a home and planning for retirement. 

Budgeting is the start of your financial planning journey towards meeting your financial goals.

What is a financial plan?

A financial plan is a process not a product. Like any process, creating a financial plan requires several steps both by you and your financial advisor. Your plan will identify and prioritize your financial goals. Some may be more immediate than others and you may have to forgo or defer others depending on the priority they hold for you. Once this is completed you and your planner can outline strategies on how to achieve them. Central to funding goals is ensuring you strategically allocate your after-tax income towards savings for those goals. This is fundamental in the budgeting process. 

Financial plans are living documents and they need to evolve as your goals and needs do. The first step in the planning process is managing your cash flow and prioritizing paying yourself first. That means your future self, not your present self.

How to pay your (future) self first

Make a budget and stick to it

Key to the budgeting process is clearly establishing needs versus wants. We need food, shelter, transportation and medical care. Individuals need to save for future expenses, known (retirement or their child’s future education) and unknown (emergencies and job losses). Individuals want leisure, travel and hobbies. 

You still have to carefully budget your needs. For instance, many people are “house rich, cash poor” from spending too large a proportion of their income on mortgage payments and other housing expenses, leaving them short of funds for everything else.

Below are two sample budgets to use as a baseline depending on your long-term goals.

For a conventional age 65 retirement, consider saving 20% of your income yearly, as follows:

• 10% towards retirement
• 5% to an emergency reserve
• 5% to other medium- and long-term financial goals (a down payment on a home, a vehicle, or any other large one-time uses of cash)

If you start your retirement savings later in life you will have to increase the percentage of your income you set aside for retirement even more, as you have a shorter period in which to accumulate funds. For instance, if you wait to start saving for retirement until age 30 but still want to retire at 65, you now need to increase your savings to 11.5% of your gross income every year.

If you want to retire sooner than age 65, you need to be aggressive with your savings. To retire at age 60, you have to make some trade-offs with your total budget as your total savings will need to be 25%, as follows:

• 15% towards retirement
• 5% to an emergency reserve
• 5% to other medium- and long-term financial goals (down payment on a home, a vehicle, or any other large one-time uses of cash)

Items such as housing, insurance and medical costs tend to be inflexible, so you will need to reduce some of your discretionary spending on personal spending and recreation.

If you start your retirement savings later in life you will have to increase the percentage of your income you set aside for retirement even more, as we have a shorter period in which to accumulate funds. For instance, if you wait to start saving for retirement until age 30 but still want to retire at 60, you now need to increase your savings to 18.5% of your gross income every year.