What Inflation Means to your Financial Plan
In 2022, it was hard to turn around without seeing news about record inflation. In Canada, inflation (as measured by the consumer price index) rose to 8.1% in June, compared to the same month in 2021.1 This was the highest level of inflation since the 1980s.2 But why is high inflation such a big deal? And what impact can it have on your daily expenses and long-term financial plan?
What is inflation and how is it measured?
Inflation is the increase in the cost of living. Let’s say a loaf of bread costs $2.00 in one year and $2.20 the next year, that increase in price of 20 cents, or 10%, is classed as inflation. In Canada, inflation is measured by the consumer price index, a basket of around 700 commonly bought goods and services monitored by Statistics Canada. These include:
- Food (groceries and eating out).
- Housing costs (rent/mortgage, taxes, utilities, insurance, etc.).
- Transportation (vehicles, transit, gas, insurance, repairs).
- Household expenses, furniture and appliances.
- Medical costs and personal care.
The increase in the price of that basket of goods is classed as inflation. We normally look at inflation as an increase in price from one month in one year compared to the same month in the previous year. Normally, inflation sits at around 2-3%. However, in June 2022, those goods and services cost 8.1% more than they did in June 2021.
When inflation is fairly low, it isn’t usually a problem. Most people’s income rises at a similar rate, so they can afford to pay for those price increases. However, inflation of 8% or higher can be a real problem if wages don’t keep up with them, which they often don’t.
What causes inflation?
A lack of supply and a large demand for products and services are typical causes of inflation. For example, due to the COVID-19 lockdowns, a lot of manufacturing stopped, and many people stayed at home, not spending money. Once the lockdowns were lifted, there was a pent-up demand for going out to restaurants, buying goods and going on vacation.
However, there were also problems with the supply of goods. Even in countries where manufacturing began again, it took time for goods to be made and shipped to other countries. The costs of shipping containers rose dramatically.3 That lack of supply and jump in shipping costs increased the price of those goods. Inflation can also happen when raw materials and labour costs increase.
The Bank of Canada and other central banks around the world often have an impact on inflation. Many central banks’ stimulus during COVID-19 lockdowns was one of the causes of 2022’s record inflation levels. The banks then started to lower inflation by raising interest rates.
How high inflation impacts your savings
Inflation can reduce the value of your savings. For example, if your investments increase in value by 4% but inflation is running at 8%, your money has effectively lost 4% of its buying power.
High inflation can be particularly challenging for retirees and their savings. They typically don’t have an inflation-matching salary to draw from and usually have to rely on their savings for much of their income. If those savings lose 4% in value (or more) over a long period of time, their investments could run out earlier than expected.
How to inflation-proof your savings and investments
Keeping your money in a cash savings account during a period of high inflation is likely to make your savings lose value. However, there are several strategies that can help your money to keep up with, and even stay ahead of, inflation.
- Having a solid financial plan with a financial advisor will protect your money against inflation’s ups and downs. Your plan will have factored in potential inflation so you can still reach your savings goals.
- Investing in stocks will typically bring much greater returns in the long run than savings accounts.
- Investing in inflation-linked products, such as inflation-indexed bonds or Treasury Inflation-Protected Securities (TIPS for short) will allow your money to grow at a rate that is directly linked to inflation’s growth.
How to start inflation-proofing your savings
A Cornerstone financial advisor can discuss all of your financial goals with you (such as saving for retirement or your child’s education) and then build a financial plan that will be designed to deliver, even during periods of high inflation.
Call us on 1.855.875.2255 to set up a meeting with a financial advisor to start helping your savings grow, in spite of inflation.
1 Financial Post: Canada’s inflation surge stalls at 6.9%.
2 Trading Economics: Canada inflation rate.
3 Wall Street Journal: Container shipping prices skyrocket.