The Bank of Canada and the Government of Canada have established a five-year monetary policy framework for the period 2022 to 2026. The main component of this policy remains an annual inflation target of two per cent (with a range of one to three per cent).
But what happens when inflation is not at two per cent? And what happens when it is not within the control range of one per cent on either side (i.e., as low as one per cent and as high as three per cent)?
For all of 2022, inflation levels were outside of the control range. Inflation reached a multi decade high this August 2022 peaking at 8.1 per cent in Canada and 9.1 per cent in the U.S.
Fortunately, we have been trending down from that high point. The most recent inflation figure for Canada was 6.9 per cent in October 2022. The most recent inflation figure for the U.S. was 7.1 per cent in November 2022.
With high levels of inflation, what does that mean for you and me? It means that your money does not go as far or buy you as much as it did a year ago.
The best way to show this question is to illustrate it with the Consumer Price Index (CPI). The Bank of Canada measures inflation using the CPI, which has eight categories:
- Food — groceries and restaurant meals
- Shelter — rent and mortgage costs, insurance, repairs and maintenance, taxes, utilities
- Household operations and furnishings and equipment — phones, internet, childcare, cleaning supplies
- Clothing and footwear
- Transportation — vehicles, gasoline, car insurance, repairs and maintenance, public transit costs
- Health and personal care — prescriptions, dental care, eye care, haircuts, toiletries
- Recreation, education, and reading
- Alcohol, tobacco, and recreational cannabis
Each of the above categories has a different weighting within the CPI. As a simple illustration, food and shelter have a greater weighting than clothing and footwear because most people spend more on food and shelter.
For example, let’s say in 2021 that Janelle goes shopping for the day. She picks up groceries, fills her car up with gas, gets a haircut, and buys a new pair of shoes. The entire shopping experience cost her $574.
In 2022, she went out and bought identical groceries, put the same amount of gas in her car’s tank, got another haircut, and bought another pair of shoes. This time Jillian’s total bill came to $626.
During this period, the price of Janelle’s basket of goods increased by nine per cent [($626 – $574) / $574]. The change in the price of these goods can be boiled down to inflation.
In 2021, Janelle was earning $74,500 annually, to retain her purchasing power, her salary would also have had to increase by nine per cent. If Jillian’s 2022 income is expected to be $81,198, her purchasing power will remain the same; however, if her expected income is anything less than $81,198, it would result in her purchasing power being eroded.
Inflation Levels
Nearly every one of my clients recall the early 1980s when both inflation and interest rates hit crazy high levels. Although inflation levels are at heightened levels, they will not stay at these levels forever. I foresee that annual inflation will move towards the target of two per cent (with a range of one to three per cent).
This does not mean that prices will go back down — that rarely happens in the long run for most goods and services.
Gold as an inflation protector
Over the last couple of decades, we have had many inquiries regarding owning precious metals during times of uncertainty. Many of these inquiries are being driven by social media, articles and advertisements our clients have seen.
I explain to my clients that millions of dollars are spent by gold companies publishing this information. We also talk about how older financial textbooks would talk about gold being an inflation protection and a non-correlated asset. The accountant side of me then comes out and I say: “The numbers don’t lie!”
In my opinion, gold has never been a great long-term investment when compared to other alternatives. When markets get volatile, and a risk-off trade happens, gold can slide materially downward.
Ten years ago, gold was priced at approximately $1,640 an ounce, today it is $1,765 per ounce. In nearly 10 years, gold has only increased 7.6 per cent. Compounding the poor long-term performance is the face that precious metals do not pay any income (no dividends and no interest income).
From a speculative standpoint, one could try to trade gold by attempting to buy lower and sell higher. The clients we work with are not interested in speculating and would rather have investments that generate dividend income and have growth over time. Investments that grow in value help protect you from inflation!
Real estate
We encourage our clients to own real estate and to stay in their home for as long as they are able.
Real estate is a natural inflation protector in that when prices rise, so do the prices of homes over time. Many of our clients who have accumulated a substantial net worth have partially attributed this through owning real estate — whether this be a principal residence, rental property, business property, or commercial real estate.
The only caveat to this recommendation is ensuring that you are not overly extended with debt obligations (mortgage costs) if the economy softens or interest rate rise substantially.
Equities
While investing in the stock market inherently has its own risks, there are many factors to manage these risks with your Portfolio Manager by determining an appropriate asset mix, an optimal number of holdings and position size, ensuring appropriate diversification to manage concentration risk, and taking a disciplined approach to the quality of equities purchased.
We hold no high-risk equities in The Greenard Group model portfolios, and we never speculate. Holding blue-chip dividend paying stocks has provided substantial investment returns over time. One of the key recommendations that I provide to all clients is always stick to good quality holdings.
Short term versus long term
Success with real estate and equities accumulates over time. All too often financial decisions are too focused on the short term.
One of my favourite components of preparing a financial plan is that we encourage people to step away from the day-to-day mindset. We really want people to view what they want out of life and their retirement.
Focusing on both short-term and long-term goals can be a stretch for some. Answer these three questions:
- What does retirement look like for you?
- What is your cash flow needs for the next two years?
- What do you anticipate doing for the next 30 plus years?
Designing a portfolio that matches the answer to these three questions enables our clients to shift away from the short-term mindset. We request that our clients estimate their cash flow needs for up to 24 months. We then put this estimated amount in cash equivalent. This component in cash equivalents enables our clients to better manage short term volatility in both the real estate and equity markets as they are not forced to sell anything at the wrong point in the market cycle.
This approach also enables the remainder of the capital to be invested in assets that have historically protected our clients from inflation.
Assumptions and financial plans
Within every financial plan, assumptions are made based on the future. Various assumptions are made, including income tax rates, inflation levels, rates of returns, life expectancy, expenditures, etc. When the plan is prepared, we gather information from our clients. We also talk to our clients about the assumptions used in this analysis, in addition to the information provided the client.
The completed plan is reviewed with clients — we always highlight the assumptions used and have clients sign an acknowledgement letter. We also mention that assumptions must be reconsidered on a frequent basis to ensure the results are adjusted accordingly. The smallest of changes in assumptions can have a dramatic impact on the outcome of the analysis.
Everyone is impacted by inflation
Everyone is impacted by inflation and it’s impossible to avoid. In our opinion, owning real estate and having a solid investment portfolio and a total wealth financial plan can protect yourself against the effects of inflation.
Steps can be done to ensure our clients maintain their purchasing power and standard of living throughout their life. While it is critical for retirees to maintain their purchasing power since they are past their earning years, we find that it is equally important to place emphasis on maintaining your purchasing power during your earning years while saving for retirement.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email [email protected], or visit greenardgroup.com.
