Inflation, Your Retirement Investments & You

Jun 29, 2022

In this retiree’s opinion, of all the possible taxes on investments, far and away the most insidious is inflation. But, unlike things like income tax and capital gains, inflation eats away at your accumulated wealth by stealth.

Compared with the early 1980s, a gallon of gas costs about two thirds more today. And the house you bought back then may well have cost around the same amount paid for a new car towards the end of last year.

Depending on your situation, the retirement nest egg you have been accumulating may be under threat.

What’s the Prognosis?

Over the course of 30 years – a reasonable retirement period for most Canadians – a 3.5% annual rate of inflation will cause the value of a dollar to fall to about 36 cents. Put another way, someone who can get by on $50,000 a year right now will need about $140,000 a year in 2041 if inflation holds at that pace.

According to data assembled by Statistics Canada, in April 2022 Canadian consumer prices rose 6.8% year over year, a slight increase from March (+6.7%). That number has risen since.

Reports Statistics Canada: “The year-over-year increase in April was largely driven by food and shelter prices. Gas prices increased at a slower pace in April compared with March, moderating the acceleration of the all-items Consumer Price Index (CPI) in April. Excluding gasoline, the CPI rose 5.8% year over year in April, after a 5.5% gain in March. This was the fastest pace since the introduction of the all-items excluding gasoline special aggregate in 1999.”

This is troubling news for long-term investors looking to build a retirement nest egg that keeps pace with, or better yet, outpaces inflation. There are three classic measures investors can adopt to protect themselves from the declining purchasing power of money during periods of inflation:

1. Ask Your Advisor About Real Return Bonds (RRBs)

Real return bonds (RRBs) are Government of Canada bonds that provide protection from inflation. They offer people a cash flow that keeps pace with the cost of living. The buying power of the cash flow remains constant over time, no matter what the interest rate or inflationary environment may be. The bond pays a semi-annual coupon rate, also known as the interest rate, that is then adjusted for inflation as measured by the Consumer Price Index (CPI). The principal amount is also indexed to protect the holder from measured price erosion.

RRBs may be attractive to people who want to keep up with inflation to help them meet future post-secondary education and retirement costs in today’s dollars. They may also appeal to those who wish to save part of the value of their estate for the benefit of their heirs. RRBs are eligible investments for a registered retirement savings plan (RRSP), registered retirement income fund (RRIF), registered education savings plan (RESP) or tax-free savings account (TFSA). Ask your financial advisor if this option is right for you.

2. Consider Adding Stocks to Your Portfolio

Stocks hedge against inflation in two main ways: many stocks pay a dividend, and they grow over time. As companies grow their net revenues, they also increase the dividends distributed to shareholders, which often provides investors with higher cash flow later on.

The higher cash flows increase the investors’ purchasing power even as the rate of inflation is rising. Also, stocks tend to grow in value in the long-term, and holding a diversified portfolio of stocks can protect investors from the declining purchasing power of money. Talk to your financial advisor before investing as each individual’s needs, goals and risk tolerance are unique.

3. Diversify, Diversify, Diversify

Another measure that investors can take to hedge against inflation is to create a diversified portfolio of stocks from around the world. When the U.S. and Canadian economies experience a decline in the purchasing power of money, other economies may be experiencing less unstable cycles that produce positive returns to investors. Again, talk to your advisor about what would work best for your portfolio.

To Sum It All Up

That said, inflation is a worldwide phenomenon. And it’s happening now. We might have to think of inflation as a long-term situation. That means preparing to deal with it over decades. The way to do this is by achieving consistent growth.

Stocks have been returning an average of 10% per year for at least the past 100 years.

Though they tend to under-perform during periods of exceptionally high inflation, they are virtually the best asset to keep your investments growing over the long term.

There are no easy answers to the inflation challenge we face, and every individual investor will, depending on his or her or their circumstances, have to craft their own (probably imperfect) solution.

Helping investors out in situations like this is what advisors at your credit union do. If you need assistance and advice, please contact one of our partners at Coastal Community Credit Union, Coastal Community Private Wealth Group or Interior Savings.

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