Inflation: What it means and how to plan for it
From budgeting to diversified investments and inflation-protected products, discover how to position your retirement savings to mitigate the impact of rising costs.
Recent years have shown us that inflation rates can climb well above historical averages, and when combined with market volatility, the impact on your purchasing power becomes hard to ignore. Even when inflation is closer to the Bank of Canada’s long-term inflation control target of 2% –which might sound small – it can erode the value of your money over time. For retirees living on fixed incomes, the impact can be significant, but there are steps you can take to help manage inflation risk.
How does inflation affect your retirement income?
Inflation is an overall increase in prices and the cost of living. Over time, the prices of some goods (i.e., bread) rise, while others may decrease (i.e., computers). Inflation measures the average increase in prices.
Simply put, when inflation goes up, the value of your money goes down.
Inflation is like a leaky tap. It may not look like a lot of water is coming out. But it's amazing the impact it can have over time.
Let’s say you put $50,000 under your mattress today. If inflation averages 3% per year, and you pull it out to spend after 10 years, it would only be worth $37,000 at present value because of inflated costs of goods and services. If you wait 20 years, it would only be worth $27,000 at present value, and so on.
Let’s break it down another way. Let’s say you received a 3% raise at the start of the year. Then, the cost of living goes up by 5% over the year. In the end, the purchasing power of your income is less, so the value of your income is less this year than it was last year.
While many people’s income will adjust to inflation over time, not everyone’s will. Many people in retirement have a fixed income which doesn’t adjust to inflation.
Inflation can pose risks when it comes to retirement planning
One of the biggest risks to retirement savings is inflation. Depending on your circumstances – like your age and when you need your money – inflation may be a bigger risk to some, and less of a risk to others.
Unfortunately, just because you’re retired doesn't mean the cost of property taxes, gas, groceries, etc. will all cease to rise. Inflation is a powerful force, especially over a long period of time. And higher costs of living mean you’ll pay more for things you need in retirement. This isn’t great timing when you’re likely not earning an income.
But inflation is only one factor in investing that you and your advisor need to consider when planning your retirement. A diversified portfolio,* including investments with growth potential expected to be higher than inflation, can be a great way to combat the effects of inflation.
How can you position your retirement savings for an inflationary environment?
No one can predict the future of inflation. However, there are a few things you can do now to give you the peace of mind you need:
- Budget and keep track of your spending. A budget can let you see your spending habits and help you find ways to save.
- Make a plan. A financial plan is a good way to help prepare for a risk like inflation. Historically, we’ve experienced periods of both high and low inflation and interest rates. A good plan accounts for a range of possibilities.
- Stick with your plan. A plan is only good if you follow it. And it’s a good habit to revisit your plan as your needs change and evolve. You’ll want to build flexibility into your plan and check in often.
An advisor can help with your retirement plan
When it comes to planning for the risk of inflation, an advisor can:
1. Assess your finances and suggest strategies that may help offset the threat of inflation.
An advisor can work to:
- understand what your risks are, and
- build a diversified investment portfolio that helps meet your goals.
2. Help you understand products that provide guaranteed income that can be adjusted each year to offset inflation.
For example, a payout annuity that offers inflation protection can help maintain your purchasing power.
- How much retirement income can you get from an annuity? Find out with our Annuity Illustrator.
3. Determine your sustainable spending rate.
This is the amount you can spend in retirement while maintaining your lifestyle. This approach helps you enjoy your retirement knowing your savings will last – factoring rising inflation.
How does it work?
- You’ll set a percentage of your portfolio you can withdraw each month.
- Each year you would increase your sustainable spending rate slightly to keep the pace with rising costs. This helps give you level purchasing power to protect against inflation.
4. Check in and reassess your plan, adjusting as unknowns become clear or your needs change.
If you have a plan in place, it likely already considers the risk of rising inflation. If you don’t have one – that’s ok! It’s never too late to start. An advisor can help.
*Key terms
- Consumer Price Index (CPI) is where Statistics Canada publishes changes in prices as experienced by Canadian consumers.
- A diversified portfolio includes various assets like stocks, fixed income and commodities. These assets may react differently to the same economic event. The value of one may rise while the value of another may fall. This lowers your overall risk because no matter what happens in the market, some assets may still benefit.
Information contained in this article is provided for information purposes only and is not intended to provide specific financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard and does not constitute a specific offer to buy and/or sell securities. Views expressed regarding a particular company, security, industry, or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc. These views are subject to change and are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. Please note, any future or forward-looking statements contained in this document are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy.