August 26, 2022 by David Christianson
There has been so much talk and press coverage about inflation over the last six months that we feared you might be tired of hearing about it.
However, in all the blather about whether inflation is transitory or here to stay, based on external factors or bad government policy, no one seems to have addressed how it affects you and what you should personally do about it. That will be our mission today.
Financial planners have always been concerned about inflation, and we always use an inflation assumption in our retirement income projections for clients. Why?
If inflation averages 3% through your retirement, then your purchasing power will be cut in half every 24 years. At a 2% average inflation rate, it takes 36 years for your purchasing power to be halved.
However, if inflation were to continue at recent rates of 7%, then your purchasing power is cut in half in just 10 years. If you are retired for 30 years, then every $1000 of purchasing power has been cut in half three times, leaving you with just $125 of purchasing power, assuming your income has not increased.
Another way of looking at this is with a retirement income projection. For example, a projection for a 65-year-old with a good investment portfolio and basic government benefits might show $117,000 per year in inflation-protected income at a 2% inflation rate, but this drops to $85,000 per year of protected purchasing power at a 5% inflation rate. Both of these assume a constant 5% return on investments.
Projections like this involve a lot of calculations and moving parts, but I’ve simplified this to isolate the effect of inflation.
Now, I don’t believe that inflation is going to continue at recent high rates and that it will return to the central bank target of 2 to 3% by the end of 2023. However, even at those lower rates, you need to take inflation into consideration in your planning.
As with all other financial planning issues, here’s a suggested way to approach:
1. Context - what does this really mean and how will it affect me?
2. Knowledge - what is my situation and my reality related to this issue?
3. Goals - what do I really want and what do I need to protect against?
4. Plan and action - what can I do and how I do it?
The published inflation rate is based on a basket of goods and services, in the broad categories of shelter, household operations, furnishings & equipment, clothing, transportation, recreation, education & reading, and alcohol, tobacco & cannabis.
You can see immediately that your personal inflation rate might be quite different than the stated rate. For example, if you are shopping for a house, a 10% increase in house prices and a 25% increase in interest rates could mean your personal inflation rate is far above the published rate.
On the other hand, if you own your own home outright with no mortgage, and have savings to invest, those factors will work to your benefit.
Statistics Canada actually has a Personal Inflation Calculator on their website, that you can use to input your own monthly and annual spending, and it will calculate your personalized inflation rate. That’s a great step forward toward your knowledge.
Another big part of knowledge is adding up your current and future sources of income. Will they increase in the future? Is that increase tied to inflation and if so, how closely? Do you have sources of income, like dividends paid by public corporations, that have a history of increasing at a greater than the rate of inflation?
Let’s look at some common sources. Canada Pension Plan (CPP) benefits are indexed for inflation but will only go up 2.7% in 2022. That’s well behind current inflation rates. By the way, the average CBP for a 65-year-old last year was $727, while the maximum is $1254, if you have paid in the maximum in 85% of the years since you were 18.
Old Age Security (OAS) is increasing at an annualized rate of 2.8% in the current quarter and will presumably go up at a higher rate in the fourth quarter of 2022. The current payment for a 65-year-old is $666 and was recently increased to $733.75 for people 75 years of age and older.
Some company pension plans are indexed to inflation, but often there is a limit, or the increase is only a partial percentage of the inflation rate. If you are a member of a registered pension plan, make sure you understand all of its provisions.
Use this information and the other knowledge about your unique situation to develop a plan, then take action.
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Dollars and Sense is meant as an introduction to this topic and
should not in any way be construed as a replacement for personalized
Please consult legal, tax, insurance and investment experts for
advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the
FP Canada™ Fellow (FCFP) Distinction, and repeatedly named a Top 50
Financial Advisor in Canada. He is a Portfolio Manager and Senior
Wealth Advisor with Christianson Wealth Advisors at National Bank
Financial Wealth Management, and author of the 2021 book Managing
the Bull, A No-Nonsense Guide to Personal Finance.