How often have you heard seniors say they paid more for their last car than they did for their first house?
When you look back at how little the previous generation had to pay for everyday items compared to what we pay, it makes you wonder where these prices are going and how much you will get for your dollar 20 years from now.
Recently, I was doing some renovations on a property that was built in the 1950s and discovered newspapers were used to insulate the walls. Looking through the ads of those papers, I was amazed that you could buy a new car in 1959 for $1,882. A sports jacket was $24.50 and short-sleeved shirt could be purchased for $2.99. Cotton jeans for boys were $1.99 and you could get 12 ASA tablets for 20 cents.
The average house price in the Toronto area was around $20,000 and the starting wage for a teacher was between $3,000 and $5,900 per year. Prices have risen considerably over the last 55 years.
Inflation is not going to go away when you retire and it is a very real threat to your savings that must be considered to ensure you do not run out of money later in life.
According to Statistics Canada, the Consumer Price Index (a measure of the cost of a basket of goods) has risen almost 208% since 1959. This represents an average of 4.19% inflation over that time.
The Bank of Canada uses interest rates as a tool to help keep inflation in check, and since 1993 they have had a target inflation rate of 2% keep our economy running smoothly. Since that target rate was initiated, the bank has been quite successful with a 20-year average increase in the CPI of approximately 1.8%.
With interest rates so low and the effects of other monetary stimulus, though, there is some uncertainty whether the 2% is sustainable.
Typically, an adviser will forecast inflation at a rate of 3% when planning for increases in the cost of living. With this in mind, if you require an inflation-adjusted return of 4% on your savings to meet your retirement target, your nominal return will have to be 7%.
To achieve this type of return in a low-interest rate environment, owners are better off than renters. Owning a company (or shares in a company) is a pure hedge against inflation because when input costs go up due to inflation, output prices are increased to maintain profitability. This is why a diversified portfolio including stocks would be appropriate to at least keep up with the changes in the costs of living.
Many believe that a core portfolio should have no less than 30% allocated to stocks around the globe to achieve this objective.
Investing in the stock market does bring with it a certain level of risk, but not factoring inflation into your savings can be a recipe for disaster.
- Doug Riding BA, CFP, FMA, is a senior investment adviser with IPC Securities Corporation.