Inflation is a concern for most people and for good reason. The forces of inflation ebb away at what your savings will buy in the future. Inflation is often intangible, however it certainly feels like everyday costs from food, house maintenance & taxes are rising at a continuous rate.
Close your eyes and visualize 2 – 2.50% each and every year being chipped away from your savings. This is the cost of living and it has risen by 3.10% on average since 1980 (bankofcanada.ca). It is essential for your portfolio to include inflation protection.
Unfortunately the inflation is a bit worse than you may realize. According to Advisor to Client (a publication we subscribe to), one of the Bank of Canada’s preferred measures of inflation (“Core Inflation”) takes the Consumer Price Index (CPI) and strips out some of its more volatile components. These include fruits and vegetables, gasoline, natural gas and fuel oil, mortgage interest and inner-city transportation. This is a problem: given the nature of these components which are daily staples, the real inflation rate is for most, significantly higher than the Core Inflation figure. This is highlighted by the chart below as overall inflation for the past 12 months was 1.3%. Drilling down, we can see that costs of Food has risen by 3.6% and Energy is down 7.8! (StatsCan, March 2016).
We factor an estimate of real inflation into financial planning projections of how much, and how long you can spend in your “next phase”. We’re careful to use figures that better reflect the actual experienced inflation rates.
There’s another side to inflation that you should be aware of. Companies don’t always like raising prices given the potential to dampen sales. Instead, they often maintain profit margins by changing packaging so they sell less product for the same price (e.g., less volume in a box), or by swapping higher-cost ingredients for lower-cost ones. It’s more difficult to see this kind of creeping inflation, but it’s there. In a service economy like ours, wage inflation is also evident. The cost for the chiropractor, dentist and hairdresser becomes slightly more expensive every year.
The Big ?
What’s your “preferred lifestyle” likely to cost throughout the next phase (retirement) from the beginning to the later years? (Create a vision for your future!) For example: If you assume a 30-year retirement, contemplate the answers to:
- How will the first 10 years be different from the last 10 years? What will I be doing?
- What are my goals and core life objectives, what’s on the bucket list that I haven’t yet done?
- What are the potential increases I can expect in the costs of my expenses?
- What are the actions needed to ensure my plan is achievable?
Our Financial Plans reflect the assumption: the “cost of living” will continue to rise for the balance of our lives.
Your portfolio must address this risk. Traditional wisdom is to increase allocation to bonds and other fixed-income securities during retirement to reduce the risk of losses to your initial capital. That may have worked when interest rates were 8% or 9%, but it’s not the reality today.
Debra & The Wooding Group