I’ve heard more about inflation in the last year than in the previous 10. It’s affecting everyone's cashflows but what about investment portfolios? Let’s dig in and talk about what inflation is, how it’s calculated and how it impacts your investment portfolio.
What is Inflation?
Inflation is the rise in prices of products and services. As much trouble as it is giving everyone lately, it is necessary for a healthy economy.
Inflation/prices are affected by three factors:
1. An increase or decrease in demand.
2. Production costs increase or decrease.
3. Consumers have more money to spend.
All three factors helped cause our recent inflation. COVID changed what we spend money on, changing demand for specific products and services. We had increased production costs due to COVID and the reshoring of jobs. Lastly, government stimulus gave consumers money.
Tracking Inflation
Countries around the world track inflation to help determine the health of their economies and set fiscal policies. The Bank of Canada has determined a 2-3% inflation rate is needed to maintain a healthy economy.
Statistics Canada tracks Canada’s inflation by comparing today’s prices of products and services to those of the previous year – Products including food, shelter, transportation, household expenses, clothing, recreation, etc. The results are our inflation rate or the Consumer Price Index (CPI).
Inflation and Investing
Now… what does this have to do with saving for your goals?
The most obvious is cashflow. The more excess cashflow you have, the easier it is to put money towards long-term goals.
Second, high inflation can eat away at the purchasing power of your portfolio. Let me explain…
Most investors want to see the dollar amount on their statement increase over time – a valid desire. However, at a minimum, you want to be able to buy the same amount with your portfolio tomorrow as you can today…if not more. Long periods of high inflation can make this challenging.
Picture this. Patty and Jim always wanted to travel to Europe. They ran the numbers and discovered they could afford to go. But with jobs and kids, they didn’t have the time. Instead, they invested the money, intending to take their trip upon retirement.
Years later, retirement is now here, and their investment has grown. Excitedly Patty and Jim dust off their old plans and start mapping out their long-awaited European getaway. However, they quickly realize their money no longer affords them the trip they originally planned. In other words, the cost has gone up faster than the growth of their investment – their portfolio lost purchasing power.
When CPI is low, this is rarely a problem, but when CPI is higher for longer, it’s something you and your Financial Advisor / Portfolio Manager need to consider and adjust for when planning for your future.
To discuss inflation’s impact on your portfolio, contact us at KLT Wealth Management.
- Courtney Beach, QAFP
