Old school financial advice that now not applies

As younger Canadians proceed to face high housing costs, slower wage growth and other challenges, centuries-old financial wisdom is becoming outdated, forcing a rethink of what smart money management looks like today. Here are some general money management rules of thumb that financial advisors say ought to be revisited.

Living space should only make up a 3rd 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 national average and doesn’t go very far in most major cities,” said Jason Nicola, a licensed financial planner at Vancouver-based Nicola Wealth. He cites research that shows how much things have modified in comparison with previous generations.

The ratio of home prices to income has risen steadily over the past few many years. Data shows that the ratio of home prices to income was about two to 3 within the early Nineteen Eighties. Now the ratio is closer to 6 or seven.

The problem of home affordability stays, even when making an allowance for today’s lower rates of interest. With mortgage rates around 4.5% today, a young couple with a gross income of $100,000 would should spend at the least 45% of their after-tax income just on monthly mortgage payments, not to say property taxes, insurance and maintenance, Nicola said.

While he doesn’t recommend it, he said it is not unusual for some households to spend as much as 50% of their monthly income on housing costs. “I think it’s just the unpleasant reality for a lot of people,” he said.

Savings will grow through the ability of compound interest

In the Nineteen Eighties, when rates of interest were between 10% and 15%, putting money in a savings account could have benefited significantly from compound interest. But with “high-yield” savings accounts currently typically offering rates of interest of two% to 4%, experts say the cash ought to be invested, not left as money.

“Maybe the interest rates and the amount you could get have changed, but the power of compounding hasn’t changed,” said Aldo Lopez-Gil, a financial adviser at Toronto-based Edward Jones. He explains that given today’s lower rates of interest, increased growth is best seen in other savings instruments resembling the tax-free savings account or the primary constructing savings account.

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

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Nicola agreed that compounding returns over time still has power, even when rates of interest are lower now. For this reason, he recommends against keeping a three- to six-month emergency fund in a standard savings account.

“Sure, it’s a great idea and it’s really nice to have something that gives you comfort. I just don’t think it’s a hard and fast rule,” he said. “[Very few] of my clients will spend six months just sitting in cash and not getting any interest.”

Start saving for retirement early

While previous generations focused on paying off debt as quickly as possible and saving the remaining, this approach could also be unnecessary for young Canadians today.

“People early in their careers are often in lower tax brackets, so an RRSP may not make much sense,” said Ainsley Mackie, portfolio manager at Verecan Capital Management. “Not all debt is bad debt. It doesn’t need to be paid off in a rush,” she said. In fact, Mackie advised that having some level of debt and regular payments would help construct credit, a “very important goal” if you should apply for a mortgage in a while.

She warns against high-interest loans for recreational items resembling ATVs and snowmobiles – common “toys” in her city of Nelson, B.C., where rates of interest on such loans may be around 21%.

Lopez-Gil believes there may be an over-emphasis on the present popular idea of ​​how much we want in retirement. “I don’t think there’s a universal payout rate that everyone could use,” he said. “The 4% rule has been talked about for decades [but] it varies depending on the person and their desired lifestyle.”

Instead, he suggests that young Canadians put money into themselves and their future income. “The uses for RESPs used to be a little more limited, but that has really opened up,” he said.

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