Inflation rates soared this year, and Canadians have endured the fasted annual increase in the cost of living in several decades. June saw a rising inflation rate of 8.1%, the highest rate increase since 1983.
The Bank of Canada has raised interest rates to rein in inflation, which is forecasted to fall slightly in the coming months. Here is some basic information about inflation and its impact on investments.
What is inflation?
Inflation represents the increase in the cost of services and goods over time. As the cost of things increases, a sum of money cannot buy as many goods and services as it could before. That is because the cost is higher or the currency’s value has decreased. Essentially, inflation is the loss of purchasing power over time.
For example, let’s say you were able to buy two loaves of bread for $6.00 two years ago. However, nowadays, you can only purchase one and a half loaves for $6.00. So, essentially, the same amount of money is worth less than before. That is inflation.
If you’re interested in seeing the inflation rate over the years, check out the Bank of Canada’s inflation calculator.
How does inflation impact my investment portfolio?
Investors refer to inflation risk as the loss of purchasing power in the future if the value of your investments does not go up with the inflation rate.
You must view your investment return minus the inflation rate. Considering the return minus the inflation rate is referred to as a “real return,” taking inflation into account and showing the decrease in purchasing power of the investment.
If you have questions about your real rate of return regarding inflation, please contact your financial advisor.
Inflation impacts types of investments differently
Inflation can pose a risk to all kinds of investments, but some assets are more affected. For example, bonds and other fixed-income securities are the most vulnerable to inflation. The higher risk is because their payments are on fixed rates. The purchasing power must decrease if the inflation rate goes up at a fixed rate.
Stocks might fair better, depending on the company. For instance, if the company you own stocks with increases their prices to match the inflation rate, and they are successful, your stocks could do okay. However, if a company has slow sales during difficult financial times, it will impact profits and the value of your stocks.
Other investments, like real estate or commodities, may benefit from rising inflation. Additionally, some investment products, like variable-rate investments and inflation-linked bonds, can help soften the blow of inflation.
Diversification is essential
Diversifying the assets in your investment portfolio has always been a key strategy in mitigating risk, including inflation risk. As mentioned, various assets are impacted by inflation and other market risks differently, so having a mixed bag is the best way to keep you on track in the long term. On the other hand, having too much of the same type of investment in your portfolio increases the risk of declining purchasing power if inflation rises.
Your financial advisor will help you strengthen your portfolio by including diversified investments across the spectrum. Your portfolio can consist of varied assets across different industries, markets, and even parts of the world.
For many people, an investment savings plan is a long game. Markets and rates can go up and down, but hanging onto your investments can help you ride it out over the long term and meet your financial goals.
If you have questions, please reach out to your Fincor Financial advisor.