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What Inflation Can Do To Your Savings

Everyone hates high prices. The unfortunate fact of a growing economy is that prices need to rise over time. This increase in price is called inflation. Inflation is a necessary evil to a successful economy because of how humans behave. What can be good for the economy is not necessarily good for our savings. Inflation can have a big impact on our savings.

Let’s face the facts. We all like a good deal and when we buy things we want it at the lowest possible price. I’m not going to argue with the few people that say if you want it just buy it. That’s not how the majority of us work. Most of us scrimp and save. Even if we can save $0.25 next week when the tomato sauce is on sale, we’ll wait to buy it. It’s this kind of mentality that makes inflation necessary. If we knew prices would fall tomorrow or the next week or the next month we’ll hold off from buying it. This leads to a self fulfilling prophecy of creating our own economic recession.

The opposite holds true when prices rise. If we know something is going to be more expensive tomorrow, then we take advantage of the deal now. That’s what inflation does. It spurs demand. Even governments know this. If building a subway is going to cost $5 billion more in 10 years, why not build it now?

Your Money Is Worth Less

The notion that prices continue to rise over time is what makes it dangerous to save money under your mattress or in a simple chequing account making no interest. Over time, the money that is put away doing nothing erodes in value.

Something that costs $100 today might cost $115 in 5 years. That means saving $100 now and doing nothing with it will mean that it’s not possible to buy that same in the future. It’s as simple as that.

For many diligent savers this has become the main problem. There are many that fear that they will run out of money in retirement so they save as much as possible now. This isn’t a bad problem, but it’s their conservative approach to invest that is. Money that is saved now making nothing in a savings account eventually erodes to the point where even saving 30% of take home income just isn’t enough to retire on. It’s crazy to think just how expensive life will be in the future without a regular income.

inflation vs gains graph

If we look at the average CPI numbers since 2002 doing nothing with your money would have a significant impact on future wealth. Throwing money under the mattress and doing nothing for 15 years would reduce each dollar’s value by 30%! That’s a significant reduction in the standard of living for someone that’s not used to scaling back their lifestyle. No more avocado toast! Maybe just plain butter spread.

Someone investing at 2% in a GIC would only be keeping up with inflation. This is better than nothing, but for people who are stuck in a rut right now, it means life isn’t going to get any better in the future. If you plan on improving your standard of living, then doing something more than a GIC is necessary. This only applies to people who are actually saving exactly the same amount they are spending right now. That means to maintain current living standards with a GIC investment portfolio one would have to save 50% of their take home. That just isn’t happening with Canadians and their paltry 0.8% savings rate.

Where things get interesting is when money is actually put to use in an investment portfolio making more than inflation. For a very conservative balanced portfolio that can average a gain of 5% a year, after 15 years, the money would actually have double the spending power. With an average growth rate of 8%, the spending value of the money would triple!

Inflation Is Not Equal

I’ve heard many times from people stating that inflation is incorrect. How can the government say prices are rising at 2% when the cost of lettuce goes from $1 a head to $2 head. That’s 100% inflation.

In fact, this is correct. Inflation isn’t equal across all things. The government calculates inflation based on it’s ideal basket of goods. Taking expenses from various sectors to figure out what the average inflation rate is. This, however, doesn’t take into consideration our own spending habits. If we spend more on food than clothing, then inflation may seem higher.

CPI Canada 2018
Courtesy of Statistics Canada

Looking at the charts, it’s obvious that items like food, alcohol and tobacco and shelter far out pace the growth in prices like recreation and clothing. These are the bigger expenses too for Canadians so it’s no wonder we are feeling the pinch more.

On top of this, inflation is not even the same across different provinces and cities across Canada. Someone on the east coast living in Fredericton might not feel the same way about prices than say someone living in Toronto.

CPI By Province 2018
Courtesy of Statistics Canada

It’s quite obvious that there is a premium to living in desirable areas of Canada. This is just the cost that people have to pay. So to those that find the cost of living reaching too far ahead of them, consider provinces that are more affordable.

What You Need, What To Do

Beating inflation is hard. We all recognize that our day to day lives are getting harder on the wallet since each and every year the amount of money that we save is getting less and less. This means we need to be proactive in making sure that we meet the needs of our retirement now rather than waiting till it’s too late.

The first thing to really do is figure out just how much money you’ll need to maintain your standard of living when you do decide to retire. A simple approach is to use an average of between 2 to 2.5% for inflation. Figure out just when you want to retire and see how much you’ll need on an annual basis.

For example, if you spend $3,000 a month now, and you expect to retire in 10 years with 2% inflation the amount you will need to spend will be around $3,656 a month. That’s the cost you’ll need to maintain your current lifestyle. Now how to get there?

If you plan on living only 10 years after retirement and invest in a GICs only then you’ll need to save $3,000 a month right now. This plan sounds pretty bad. What happens if you live longer than 10 years? Where’s the backup plan?

This is where we need to get realistic in our retirement planning. Saving and investing in GICs is generally not enough¬†and the reason is quite clear: Inflation. Canadians in general are too risk adverse. This is why the government is insisting on increasing CPP premiums for the future because it’s been identified that Canadians don’t know how to invest and save for the future.

For those that do want to learn and be independent of government assistance it’s better to act early than later. Remember that time is the most important thing that we can’t get back. The earlier you start the more prepared you will in fighting inflation.

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