In personal finance there are set rules for major decisions, such as how much to save for emergencies, the most you should pay for housing and how much you should put aside to invest. But has the COVID-19 pandemic changed the landscape? Is it time to rewrite the rules? Let’s take a look at some of the big ones to see whether they’re still helpful.
Save three to six months of expenses in an emergency fund
Emergency funds are a must-have in personal finance: it’s cash you have set aside to pay for housing, food and bills in the event of a job loss or medical emergency. Before the pandemic, nearly half of Canadians treated emergency funds as a nice-to-have, with many living paycheque to paycheque.
“Cash is king,” says Toronto-based certified financial planner Jackie Porter. “I think that’s what we’ve learned in this somewhat traumatic time.”
Standard personal finance advice states that you need three to six months of cash to be on the safe side. Is that still the case?
Not for Bridget Casey. The founder of Money After Graduation, a financial literacy website based in Calgary, says she used to recommend people save up to three months’ worth of expenses.
“Now I’m like, Oh my God, you should be aiming for a year’s worth of savings,” she says.
Ms. Casey knows that’s an ambitious goal, especially since it’s already tough to save. “What I communicate to people is that for an emergency fund of that size, you don’t have to save it all in one year.”
The 30 per cent rule
This long-held rule states that no more than 30 per cent of your gross income should go toward housing costs. For renters, that 30 per cent includes utilities and for homeowners, it covers costs such as property taxes, mortgage interest, maintenance and utilities.
If you earn $4,000 a month, your housing costs should be about $1,200. The problem, of course, is that house prices have skyrocketed in the past year. The average house in Canada sold for $695,657 in April, up 42 per cent from a year ago. In Toronto and Vancouver, the average price is more than $1-million.
“Cities in Canada are expensive,” says Ms. Casey. “The 30 per cent goal is unattainable because it ignores factors such as current market rents and home prices.”
The 30 per cent rule was created to make sure that people had money left over for other financial goals and responsibilities: paying for education, repaying debt, raising children and saving for retirement.
Ms. Casey says it’s okay to spend more than 30 per cent on housing, depending on your age, goals and priorities. “If your housing costs 40 or 50 per cent in your 20s and 30s, that’s fine,” she says.
Ms. Porter disagrees: “That’s a lot of your income going to housing, and I don’t know if that’s necessarily the best thing,” she says.
In order to keep housing costs reasonable, Ms. Porter suggests moving to a less expensive area. Although housing prices have shot higher in smaller cities and suburbs during the pandemic, these areas are still far more affordable than the big cities.
Invest 10 per cent to 15 per cent of your annual income, starting in your 20s
If you wondering what percentage of your income you should be investing, there’s a rule for that: 10 to 15 per cent.
No one can deny that setting aside up to 15 per cent of your annual income can be a great way to grow your wealth. But the cost of housing, transportation and food keeps increasing, while wage growth has not.
So do regular Canadians have that left over after fixed expenses? And do they need to allocate that much in the first place?
“More is always better,” says Ms. Casey. “But you don’t always have to start with that much.”
That’s why Ms. Casey suggests you start with 1 per cent of your annual income, then work your way up.
“When you’re young, time is your friend,” adds Ms. Porter. “People don’t realize how powerful it is when you’re putting money aside regularly, whether it’s 15 per cent, 10 per cent or 5 per cent.”
100 minus age rule
This rule states that you should subtract your age from 100, and invest that percentage in stocks and the rest in fixed income. So at the age of 40, your stock allocation should be 60 per cent, with the rest in bonds. At age 60, 40 per cent of your portfolio should be in equities and 60 in bonds, and so on.
But how does this rule hold up in today’s market? Bonds are meant to reduce volatility as stocks go up and down and have long been the solution for investors seeking capital preservation. But record-low interest rates have made it tough to earn a return with this strategy, so it may not produce enough for a stable retirement.
“Yields have been at a near-zero rate since 2009 when we had the last major financial crisis,” says Ms. Porter.
That’s why both Ms. Casey and Ms. Porter agree that it’s not necessarily a bad rule; it just might be too conservative.
There are other factors to consider when deciding on an asset allocation besides age, such as risk tolerance and personal goals. Instead of blindly following a rule, each individual must investigate the implications of those rules and what your circumstances are.
The bottom line is that rules can be helpful, but you need to understand the thought process behind the rule to see whether it makes sense to apply it.
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