How inflation impacts your investments

Got questions about inflation?

Rapidly rising prices for goods and services, both in Canada and internationally, made headlines throughout 2021. And, by all accounts, domestic prices are expected to continue to rise above the Bank of Canada’s target range for inflation into 2022, and possibly beyond.

In terms of investing, is inflation something you need to worry about? As with any aspect of the financial markets and the economy, a little perspective can go a long way. Below, we explore what it could mean for you and your money.

What is inflation?

There are numerous indicators that help economists and investors monitor the overall health of the economy; unemployment and job-growth rates, gross domestic product (GDP), and trade deficits and surplus, are just a few. Not only is it an extensive list, but each can tell a different story at a specific point in time, adding to the layers of complexity.

Inflation is an indicator that is garnering a lot of attention these days. At its most basic level, inflation measures how prices change over time and how that relates to the “purchasing power” of money. In other words, how much does a given amount of money buy over time?

Inflation is often represented by the percentage change in the consumer price index (CPI). The CPI measures the cost of a basket of 700 select goods and services, including groceries, gasoline, furniture, clothing and recreation.

The Bank of Canada’s current mandate is to keep inflation (or the increasing cost of that basket) between 1% and 3%, annually. To do that it uses the policy tools it has at its disposal, including the power to change interest rates.

Why is inflation heating up?

2021 saw a dramatic shift in economic activity – especially as pandemic-related restrictions began to lift across Canada and around the world. The resulting global supply-chain disruptions have created conditions for inflation to prosper.

Regional virus outbreaks. Shortages of raw materials. Energy-supply concerns. All are obstacles in making goods and services available as consumer demand returns. Fewer goods means higher prices for those limited goods.

At the same time, unprecedented levels of government spending, coupled with ongoing bond purchases by the Bank of Canada and record low interest rates, injected billions of dollars into the financial system to support the economy through the pandemic. This stimulus has helped fuel demand even as prices rise.

Inflation has been above the Bank of Canada’s target range since April 2021, and it’s expected to stay elevated through 2022. The good news is that the bank has said it will keep interest rates near zero to support Canada’s economic recovery from pandemic impacts, and isn’t forecasting a rate increase until the spring or summer of 2022. Policymakers see inflationary pressures easing as prices are no longer compared to the lows of the pandemic, and as supply bottlenecks work themselves out. As Bank of Canada Governor, Tiff Macklem, noted in October 2021: “It might take a little bit longer, but we do continue to believe there are good reasons why the impact of these supply disruptions on inflation should be temporary, and there are good reasons to believe that the economy, the recovery, will pick up and continue.”

What does it mean for your investments?

Inflation means higher consumer prices and potentially higher interest rates at some point. The higher they go, and the longer they persist, the harder it will be to reach your goals over time. The amount you will need to save to reach your goals must at least keep up with inflation or your savings will erode as prices for common goods and services increase over the long term due to inflation.

To put it bluntly, keeping your money in a bank account (or under your mattress!) provides zero protection from inflation.

What can you do?

The best way to guard against inflation is to ensure that you have a solid financial roadmap – featuring a diversified investment portfolio, with some exposure to equities – from the start. The equities in your portfolio will provide an opportunity for growth, while the fixed-income assets act as a counterweight. (The ratio of fixed income to equities will depend on your own risk tolerance and investment objectives. A Co-operators financial representative would be happy to help.)

If you’re retired and a fixed income is part of your financial scenario, it’s especially important to talk to your advisor regularly to ensure that your investments are keeping up with inflation.

It’s always a good idea to save more than you think you’ll need. And to start as soon as you can to maximize compounding growth. It’s also important to reduce personal debt by as much as possible, so you can keep up with payments if interest rates rise.

At Co-operators, any mutual funds or segregated funds that we recommend are based on your personal situation and investment profile, while the composition of each fund is chosen by a professional money manager to meet its objective. That means factoring in all your investment risks, including inflation.

For more information and resources, visit Market View and Resource Centre. You can also read our weekly Investment Update for deeper insight into the latest news driving financial markets.

*In the province of Quebec, the authorized representatives are Financial Security Advisors who have been duly certified by the Autorité des marchés financiers.

The information contained in this report was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete and it should not be considered personal taxation advice. We are not tax advisors and we recommend that clients seek independent advice from a professional tax advisor on tax related matters. Mutual funds are offered through Co operators Financial Investment Services Inc. to Canadian residents except those in Quebec and the territories. Segregated funds and annuities are administered by Co operators Life Insurance Company. Co operators Life Insurance Company and Co operators Financial Investment Services Inc. are committed to protecting the privacy, confidentiality, accuracy and security of the personal information that we collect, use, retain and disclose in the course of conducting our business. Visit www.cooperators.ca/en/PublicPages/Privacy.aspx for more information. Co operators® is a registered trademark of The Co operators Group Limited.