Do you remember the good old days: $5 footlongs at Subway, Toonie Tuesdays at KFC or a BigMac extra value meal for less than $5? The price of these delicious meals long ago versus the prices now are examples of inflation. Sadly, this has drastically affected my fast food addiction. In this blog, I am going to do my best to describe inflation, how it can hurt your future self and some options you have available to reduce its effects.
Putting things into perspective
Before I begin, let me give you some examples that do not relate to food. To start, what you could have bought 20 years ago with $100 will cost you $143.77 today. (Source: https://www.bankofcanada.ca/rates/related/inflation-calculator/) On a larger scale, if your income needs are currently $50,000/year and you are planning to retire in 20 years with the same level of income, you will need to have saved enough to generate $71,885/year.
Another more common example would be the ‘COL’ or cost of living increase many people receive from their employers at the beginning of each year. This is an increase to keep up with inflation and to ensure that your income can provide the same lifestyle as the previous year. To me, this is the most important consideration.
Inflation can change on a year to year basis, and unfortunately, it does not appear it will not go away anytime soon. In response to the COVID pandemic, our government announced stimulus packages, like CERB which in turn increased our money supply. So, there is a chance we will likely see some years ahead of us of higher inflation.
Ok, so what if I have to spend $8.50 now on my meatball sub. What does this mean to the average investor?
It means that the risk of losing money in the market is not the only risk to consider. With interest and investment rates at all-time lows, it means that most investors can’t get away with just piling all their money into savings accounts, GICs or money market funds anymore. Because, even if they factor in inflation of 2% and a modest tax rate of 25%, they need a 3% return on investment just to break even. (Source: CANSIM-Statistics Canada, Datastream) And I think many economists would argue that a 2% inflation estimate would be on the low side.
Side note, if you can find any of these 100% secure investment products yielding close to 3% let me know!
So how should I factor inflation into my investing?
This means we have to look elsewhere for investment returns. One area we can look to is equities or stocks. No, this does not mean you need to trade your own stocks or try to pick the next Amazon. There are ways of gaining exposure to equities through mutual funds, ETFs and index funds while keeping your risk level relatively low. With people having longer than ever life expectancies, having your money last for 30-40 years in retirement should be just as big of a concern to investors. Those that are in their 50s or 60s may not think they have a long time horizon, but the life expectancy statistics would argue otherwise.
If we separate your short, mid and longer term savings into “buckets” there is little reason why most investors should not have at least their longer term savings “bucket” exposed to some equities. Of course, if you believe in the long term wealth building power of real estate or gold…or bitcoin…all the power to you. The point is that you need to hold something that gives you the chance of enhancing your overall returns over time so it will not get eaten up by inflation resulting in your money lasting longer. We can talk about the merits of each of these specific investments any time, but for the purposes of this blog, I won’t.
Investing is a marathon and not a sprint. Unless you are actively trading stocks on your own, which is statistically the riskiest way to invest, investing is likely not going to be a thrilling and captivating journey for most. Yes, neighbour Bob might not be lying about the 400% return he just made on Dogecoin in the last few months. Remember, those examples are few and far between and not the average investor’s story.
We are still moving through the effects of COVID, and will be for many years into the future, but I’m sure you know about that already. Businesses will adapt as they always do, and will find new ways of doing business. The ones that innovate and create new models will thrive and the ones that refuse to change (Blockbuster Video) will die off, just like all the ones before them.
In late June 2020 CNBC reported there is almost 5 TRILLION dollars sitting in money market funds in the US. This doesn’t even include deposits at banks which have also spiked. https://www.cnbc.com/2020/06/22/theres-nearly-5-trillion-parked-in-money-markets-as-many-investors-are-still-afraid-of-stocks.html). This indicates that there are a lot of nervous investors out there, but also shows that the markets can be supported by all this cash currently sitting on the sidelines.
And the price for sitting on the sideline too long, is that inflation will take a bit out of your investment returns.
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