Saving refers to the deliberate reduction in consumption of something, usually, money, time, or any other resource. In this article, we discuss savings in Canada in terms of money.
We earn money through different ways, Wages & Salaries, Inheritance, Royalties, or Income from various Investments such as stocks or businesses that we own.
As they say, “Life is full of surprises”. Our means of livelihoods are often volatile. The level of yields and earnings may vary from time to time for diverse reasons, sometimes no visible reason at all. It can be due to an act of God like, earthquake, flooding, government policy, or a strange pandemic.
In dire times, some of our streams of income may even dry up completely. Our expenses on the other hand are limitless. They never stop. For instance, we have to eat every day and have a place to lay our heads, keep clothes on our backs etc.
Therefore, there is a huge need to set aside a portion of our income today for the rainy day or simply to make a big purchase or to go for a fancy vacation, etc.
Reasons for Saving
– To fund luxury purchases. A TESLA Car, that new model of iPhone, or the Gucci belt you’ve always wanted.
– To fund future investments
– To fund future expenditures such as rent, tuition, surgery, or your dream wedding.
– To prepare for the rainy day.
– For Retirement purposes
How much should you save?
When we earn Income, ideally there are three things that we can possibly do with it. We pay taxes, make consumptions and make savings. Making purchases, gifts for our loved ones, Rent, debt repayment etc. all fall under Consumption
Theoretical Approach to analyzing Savings and Income
In Economic theory, the statement above can be summarized as follows
This implies that our Income is either spent or saved.
Y= C – S
Where Y= Income, C=Consumption, S = Savings.
When it comes to the ideal amount for an individual to save, the consumption equation is our main focus.
C= a + bYd
It literally denotes that our Consumption consists of “Necessities, Frivolities and Taxes”.
C = Consumption
a = Necessities: this involves the basic necessities of life that every individual must pay for to live a dignified life. This includes things like food, water, and shelter.
It can also be expanded to include transport costs for daily commute to work, electricity bills, phone bills or any expenses that we must incur in our quest to earn a daily living. In fact, whether we make income or not we must spend incur these expenses by default. They are also sometimes called exogenous expenditure.
Yd = Disposable Income (Y- T): Ever heard the saying two things are certain in life “Death and Taxes.
Taxes (T) are a constant part of our lives. Even when you inherit some money, the taxman must get his cut.
This means that when you get your paycheck, you are not simply allowed to spend all of it. You have to deduct your tax payments before you can arrive at your disposable income. In most countries, the higher you earn the higher you have to pay in taxes.
As individuals, we pay taxes on our weekly wages and salaries. Companies also pay taxes on their annual profits. Tax evasion may lead to heavy sanctions or jail term.
Whatever we have left after this tax has been deducted is called Disposable Income. You have to arrive at your disposable income first before you begin to draw up your budget or set a savings target.
So we have the next equation; Yd=YT where, Y= Income, T= Taxes
b = Marginal Propensity to Consume (MPC) & Marginal Propensity to Save (MPS)
The concept of MPC and MPS captures our individual spending habits and desires. They are the actual determinant of how much each of us is willing to save out of a given level of income.
Think of MPC and MPS as two sides of the same coin. They are the weights that each of us assigns to our willingness or tendency to spend at our current of level income and at a particular period of time.
In simple terms, it’s like asking yourself, at your current level of income, after paying your rent, transports, recurrent bills, and taxes settled, how much you are willing to save out of each remaining dollar.
MPC and MPS are weights between 0-100. So, one point assigned to MPC means one point less for MPS.
I.e. 60% MPC automatically means your MPS is 40%.
Some of us are prepared to spend our entire paycheck. A person like this can be said to have 100% MPC. Conversely, some of us actually plan to save a portion of our Disposable Income. Saving 30% of your disposable income means a MPC of 70%.
Now the mathematical jargon C=a + bYd makes more sense right?
It means that Consumption is equal to spending on Necessities plus our individual tendencies to splurge.
Having established what consumption means we can then move to state our savings function
S=Y- a – bYd
This means that we can arrive at our potential savings figure by deducing our Necessities and Taxes from our income, then expressing the rest based on our MPS figure, (100% – MPC).
Similarly, if you are prepared to save all that is left of your Disposable income then you can say that your MPS = 100% (and by extension MPC = 0).
How much should you save Monthly in Canada?
To create an effective savings plan, you must employ a realistic approach. You can achieve this by first of all identifying the factors that affect your willingness and ability to save or consume on your next dollar.
NOTE that your ability to save and your willingness to save are two different things. Both of them jointly affect the level of saving you will be able to reach at a particular time.
Factors that Affect Marginal Propensity to Save
- Income Level
As a general rule of thumb, the higher you earn, the higher you are ‘able’ to save. i.e. If your income is so low that you can barely afford to meet up your necessities, then you are unlikely to save.
Average Income Level in Canada – In 2020, the average Canadian salary was about $65,000 CAD, which works out to around $5,400 CAD in a month.
2. Cost of Living
Although this is largely out of your control, it is one of the most crucial determinants of how much you will be able to save. The cost of living in different locations around the world is very different. Typically cities with the highest cost of living also offer higher wages.
Living in a city comes with certain costs that you simply cannot avoid such as monthly rent costs, transport costs, and food costs.
You have to factor in the cost of living before drawing up a savings plan.
Cost of Living in Different Cities in Canada
A $1000 paycheck in some parts of Canada can be considered rich in some in some cities while it will leave below poverty like in another city.
The Average Monthly Cost of Living in Canada is estimated to be about $2,500 CAD. approx.
Expensive Cities: Vancouver: $3,000 CAD Toronto: $2,700 CAD (monthly costs), Montreal $2,500 CAD
Affordable Cities: Sherbrook, Quebec: $700 CAD
The government levies taxes on all citizens in order to provide social amenities and infrastructures. This also affects the portion of our income that we have left for savings or consumption.
Taxes in Canada
Federal Income Tax in Canada as of 2020 was 15% (although it may increase of people who earn above $50,000 CAD)
The number of dependents you have also goes a long way in determining how much you will be able to save. If you have children or aged parents, spouse, or friends that depend on you for daily survival, this will affect how much you are able to save for the future.
Typically the dependent population are people in a country that are below legal working age 0-15, or above retirement age 65+.
As of 2019, the dependency ratio of the Canadian population was 50.36 percent.
Meaning that of Canada’s 37.6 million only about 18.6 million are of working age.
Expected Monthly Saving in Canada
To arrive at how much you should be able to save on a monthly basis in Canada we must compute the Savings function based on the information identified above.
Expected Savings = Average Monthly income – Taxes – Average Cost of Living
= $5,400 – (15% of 5,400) – $2,500
= $5,400 – $810 – $2500
Expected savings = $2,090
Therefore you should save at least 38.7% of your income. That is if you live on a shoestring budget i.e. purchasing only what you need and paying your taxes.
Willingness to Save
By this computation, we can say that the Average Canadian should be able to save monthly. But in reality, things are much more complicated.
The actual percentage of it that eventually gets saved varies from one individual to another. Basically based on your willingness to save.
That willingness, tendency, or propensity to save is influenced by a host of factors.
– Personal Sentiments – The quality of life desired by each person is different. This influencing our consumption habits.
– Seasonal Choices – Life is in seasons. Events such as Birthdays, Anniversaries, Christmas, Thanksgiving, or Easter all go a long way to influence our savings decision at a particular period of time. We make different saving choices across different seasons. i.e. Christmas & New Years’ festivities see people spend a whole lot more on vacations, gifts, etc.
– Age – Our ages also influence our habits in all areas of life. Typically older people feel they don’t have much longer and may decide to spend more of their disposable income on quality life experiences like fancy vacations.
Younger people may feel they have enough time to work and save later in the future, hence they have tendencies to consume a larger portion of their income.
Generally, people in their 40s tend to save more than people of other age groups.
– Future Plans/Ambitions – We all have different ambitions and plans for the future. such as to Start-up a business, Purchase a home, or any assets to Bequeath to your kids. Relocating to a new city or simply have a fancy Vacation. This can be said to be the major decider of our saving habits.
How often should you save?
Ideally, you should match your savings pattern to your earning frequency. Weekly, Bi-weekly, Monthly or Annually.
Automating your saving deduction can also help you to achieve your targets.
Speak to your bank to get information about various Saving options available in Canada
– Separate your savings account from your checking account
– Look out for good Interest rates so that inflation doesn’t erode the value of your savings over time.
– Be disciplined
– Be consistent
– Set your own targets and move at your own pace. Don’t compare your savings plans to other people
– Be realistic.
And lastly, YOLO. A bit of splurging from time to time wouldn’t hurt… as long as it doesn’t cripple your savings.