Harnessing the power of automatic contributions

While 65% of Canadians are actively putting away money for retirement, most of us aren’t saving nearly enough. According to Stats Canada, Canadians’ average retirement savings are only $184,000—far short of where they need to be in order for most of us to maintain our working standard of living.

Obviously, we all understand that at some point we’re going to stop working, and that we’ll have to rely on our savings to survive. So why is setting money aside for the future such a challenge for so many of us?

Science suggests that it isn’t just bad judgment. In fact, our brains have evolved to privilege our immediate needs over those that may arise in the future—as well as to take the easiest course of action in general, and avoid difficulty wherever possible.

Unfortunately, in most people’s minds, saving for retirement takes both of these things: forgoing gratification in the present, and putting effort into planning our financial future.

One way to circumvent these obstacles is to use automatic contributions to fund our registered accounts.

By automating the savings process, automatic contributions help us to avoid temptation and stay on course—paradoxically, by taking individual will power and discipline out of the equation altogether.

The science behind successful saving

It’s easy to beat ourselves up about our habits with money—spending too much and saving too little.

But finding the discipline to save is challenging for almost everyone, and it’s not just due to a lack of will power, or living in a society that encourages us to live (and consume) in the present.

According to behavioural economists, who study the way we think and act around money, there are very real psychological obstacles that prevent us from doing what is good for ourselves in the long term.

Human beings are skilled at focusing on immediate needs rather than those in the future—which is why spending our money on things that give us instant gratification is so much easier than stashing it away for a rainy day or retirement.

Additionally, as you may know from experience, we tend towards inertia. If you’ve never regularly saved, getting started can be the hardest part.

Thankfully, we can use this fact to our advantage.

Shlomo Benartzi, a Professor of Behavioral Decision Making, believes that when you make the responsible choice the easy choice, people sign up for it.

That is, knowing that people prefer to do nothing, when it comes to long-term goals, making their savings contributions automatic is hugely beneficial. Once they’re set up, savings grow with no effort required.

The difference is between relying on your own effort, discipline and sense of responsibility to save money every paycheque, and putting yourself in a position where it would actually take more effort to stop saving. You can guess which one is more effective.

Psychological and financial benefits

Making automatic contributions to your RSP or TFSA ensures that your retirement savings grow consistently, with no effort required on your part once you make the initial decision to get them set up.

In addition to the obvious financial benefit, recurring contributions give you the psychological benefit of knowing you’re investing in your future, which can be a great source of financial confidence and security.

Planning for retirement and building your nest egg means less stress, and counterintuitively, a greater ability to enjoy the present, knowing that the future is taken care of.

And finally, while many self-directed investors will contribute regularly in the form of cash, and then invest it when the time is right, those who choose to invest their recurring contributions directly into a mutual fund enjoy another benefit: regularly investing regardless of what the market is doing.

This is an excellent strategy, and the opposite of attempting to time the market. For more on why this approach works, check out this article on dollar-cost averaging.

Making the most of your registered accounts

If you’re ready to set up automatic contributions to your RRSP or TFSA, it helps to know your contribution limits, so you can ensure you’re contributing enough to max them out, or to come as close as possible.

For 2018, your personal RRSP contribution limit is 18% of your pre-tax earned income for the previous year, up to a maximum of $26,230  (less if you have a company pension plan).

The TFSA limit is $5,500. Your notice of assessment from last year will state if you have unused contributions for both accounts.

So, for example, if your gross salary is $100,000, this would allow an $18,000 RRSP contribution. Saving $1,500 every month would maximize your contributions. Saving $458.33 per month would maximize your TFSA allowance.

Setting up a recurring contribution is simple with Qtrade Investor

If you’re not using recurring contributions yet, Qtrade Investor makes getting setup easy. Simply log in to your Qtrade Investor account and under My Account, select Transfer Funds. From there, you can add a financial institution and set up your automatic transfer in a single step.

If you hold mutual funds in your registered accounts, you can establish a systematic plan to invest in them directly. If you currently hold less than $25,000 in your account, we’ll waive your quarterly admin fees if you set up a recurring contribution of $100 a month or more.

Remember: while maxing out your contributions for retirement is the goal, don’t be discouraged if that’s not financially realistic for you right now. The point is just to save something—even if it’s a small amount—and to make the process as simple, consistent and effortless as possible.

Over time, whatever you’re contributing will compound, encouraging you to keep going, armed with an increasing sense of financial freedom and security.

References

Jonathan Chevreau, “The magic number for retirement savings is $756,000, according to poll of Canadians.” Financial Post, February 8, 2018. http://business.financialpost.com/personal-finance/the-magic-number-for-retirement-savings-is-756000-according-to-poll-of-canadians (Accessed April 12, 2018).

ii John Besheras, Katherine Milkman. Laura Burke, Alison Fahey, “The science behind why you don’t save (and what to do about it).” Time Money, July 26, 2016.  http://time.com/money/4417515/science-saving-emergency-expenses-behavior-economics/ (Accessed April 11, 2018).

iii Shlomo Benartzi, “How Digital Tools and Behavioural Economics Will Save Retirement.” Harvard Business Review, December 7, 2017.https://hbr.org/2017/12/how-digital-tools-and-behavioral-economics-will-save-retirement (Accessed April 11, 2018).

iv MP, DB, RRSP, DPSP, and TFSA limits and the YMPE.” Government of Canada, December 21, 2017.  https://www.canada.ca/en/revenue-agency/services/tax/registered-plans-administrators/pspa/mp-rrsp-dpsp-tfsa-limits-ympe.html (Accessed April 12, 2018).