As younger Canadians continue to face high housing costs, slowing wage growth and other challenges, age-old financial adages have become outdated, forcing a rethink of what smart money management looks like today. Here are some common rules of thumb for money management that financial advisers say need re-examining.
Housing should only take up a third of your budget
“If you’re trying to stick to this rule, you can only afford to buy a home that’s $500,000, which is well below the average across the country, and it doesn’t go very far in most major cities,” said Jason Nicola, certified financial planner at Vancouver-based Nicola Wealth. He cites research that shows just how much things have changed from previous generations.
The home price-to-income ratio has steadily grown over the past several decades. Data shows that in the early 1980s, the home price-to-income ratio was about two to three. Now, the ratio sits closer to six or seven.
The home affordability challenge remains even after accounting for today’s lower interest rates. With mortgage rates of about 4.5% today, a young couple with $100,000 in gross income would have to spend at least 45% of their after-tax income just to cover monthly mortgage payments, let alone pay for property taxes, insurance, and maintenance, said Nicola.
Though he doesn’t recommend it, he said it’s not uncommon to see some households spend up to 50% of their monthly income on housing costs. “I think it’s just the uncomfortable reality for a lot of people,” he said.
Savings will grow with the power of compound interest
Setting cash aside in a savings account may have benefited significantly from compound interest in the ’80s when rates ranged between 10% and 15%. But with “high-interest” savings accounts currently typically offering rates of 2% to 4%, experts say money should be invested rather than left sitting as cash.
“Perhaps interest rates, the amount that you could receive has changed, but the power of compounding has not changed,” said Aldo Lopez-Gil, a financial adviser at Edward Jones based in Toronto. He explains that given lower interest rates today, compounding growth is best seen in other savings vehicles like the tax-free savings account or first home savings account.
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“I think there’s a gap in terms of education and understanding as to what investments can be put into a TFSA,” said Lopez-Gil. “In my experience, it’s a completely underutilized account by Canadians.”
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Nicola agreed that there is still power in the compounding of returns over time, even though interest rates are lower now. That’s why he discourages keeping a three- to six-month emergency fund in a traditional savings account.
“Sure, it’s a great idea and it’s a really nice thing to have that gives you comfort. I just don’t think it’s a hard and fast rule,” he said. “[Very few] of my clients are going to have six months of spending just sitting in cash not earning any interest.”
Start saving early for retirement
While previous generations focused on paying down debt as quickly as possible and saving what remained, this approach may be unnecessary for young Canadians today.
“People early in their careers are often in lower tax brackets, so an RRSP might not make much sense,” said Ainsley Mackie, portfolio manager with Verecan Capital Management. “Not all debt is bad debt. It doesn’t have to be rushed to pay it off,” she said. In fact, Mackie advised that having some debt and making regular payments will help build credit, a “super important goal” if you’re going to apply for a mortgage later.
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She cautions against high-interest loans for recreational items like ATVs and snowmobiles—common “toys” in her town of Nelson, B.C., where rates on such loans can hover around 21%.
Lopez-Gil thinks the current widespread perception of how much we need in retirement is overly emphasized. “I don’t think there’s a universal withdrawal rate that everybody could use,” he said. “The 4% rule has been talked about for decades [but] it does vary by person and their desired lifestyle.”
Instead, he suggests young Canadians invest in themselves and their future earnings. “RESPs used to be a bit more restricted in terms of what you can use it for, but that has started to really open up,” he said.
This advice comes as career paths for young Canadians look very different than they did for previous generations.
