Old-fashioned financial advice that no longer applies

As younger Canadians continue to face high housing costs, slowing wage growth and other challenges, age-old financial adages have become outdated, necessitating a rethink of what smart money management looks like today. Here are some general money management rules of thumb that financial advisors say need to be reexamined.

Housing should only take up a third of your budget

“If you try to stick to this rule, you can only afford to buy a home for $500,000, which is well below the average across the country, and in most major cities it doesn’t go far,” says Jason Nicola, certified financial planner at Vancouver-based Nicola Wealth. He cites research that shows how much things have changed from previous generations.

The ratio of house prices to income has grown steadily in recent decades. Data shows that the ratio of house prices to income was about two to three in the early 1980s. Now the ratio is closer to six or seven.

The housing affordability problem remains even when current lower interest rates are taken into account. With mortgage rates around 4.5% today, a young couple with a gross income of $100,000 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, Nicola said.

While he doesn’t recommend it, he says it’s not uncommon for some households to spend up to 50% of their monthly income on housing costs. “I think that’s just an uncomfortable reality for a lot of people,” he said.

Savings will grow thanks to the power of compound interest

Putting cash aside in a savings account may have benefited significantly from compound interest in the 1980s, when interest rates were between 10% and 15%. But because high-interest savings accounts currently typically offer an interest rate of 2% to 4%, experts say money should be invested instead of leaving it as cash.

“Maybe interest rates, the amount you can receive, have changed, but the power of compound interest hasn’t changed,” said Aldo Lopez-Gil, a financial advisor at Toronto-based Edward Jones. He explains that given the current lower interest rates, compound growth is most visible on other savings instruments, such as the tax-free savings account or the first home savings account.

“I think there is a gap in terms of education and understanding what investments can go into a TFSA,” Lopez-Gil said. “In my experience, it is a completely underutilized account by Canadians.”

Nicola agreed that there is still power in compounding returns over time, even though interest rates are lower now. That’s why he discourages keeping an emergency fund with a term of three to six months in a traditional savings account.

“Of course, 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 customers will have to spend money for six months without earning any interest.”

Start saving for your retirement early

While previous generations focused on paying off debt as quickly as possible and salvaging what was left, this approach may not be necessary for young Canadians today.

“People early in their careers often fall into lower tax brackets, so an RRSP may not make much sense,” says Ainsley Mackie, portfolio manager at Verecan Capital Management. “Not all debt is bad debt. You don’t have to rush to pay it off,” she said. Mackie even 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.

She warns against high-interest loans for recreational items like ATVs and snowmobiles – common “toys” in her city of Nelson, BC, where interest on such loans can hover around 21%.

Lopez-Gil believes that the current widespread perception of how much we need in retirement is overemphasized. “I don’t think there’s a universal withdrawal rate that everyone could use,” he said. “The 4% rule has been talked about for decades [but] it does differ per person and per desired lifestyle.”

Instead, he suggests that young Canadians invest in themselves and their future earnings. “RESPs used to be a little more limited in terms of what you can use it for, but that’s really starting to open up,” he said.

This advice comes as career paths for young Canadians look very different than for previous generations.