A large percentage of the population invest their money in safe, guaranteed investments to protect their life savings from the uncertainty of the stock market. What they don’t realize is that these “secured” savings are slowly losing value from inflation without them even knowing it. To understand this phenomena, we must first learn what inflation is and how it affects the buying power of your money.
What Is Inflation?Inflation is the increase in the price of goods and services or an increase in the supply of a country’s currency. It’s the reason why my parents could buy a bottle of pop, a bag of chips and chocolate bar for $0.25 when they were kids; yet it cost me $2.50 for the exact same things when I was young.
While inflation is a product of GDP growth which is necessary for a healthy economy, it has a nasty side effect of making your hard earned money worth less over time. There is no easy way to calculate an exact inflation rate but if you keep track of the prices for goods and services over course of a few years, you’ll see the slight increases start to add up.
Rising PricesThere’s nothing like walking through the grocery store or pulling up to the gas pumps to bring on the panic of inflation. According to Statistics Canada, the inflation rate in Canada was only 0.4% in April. I’m not sure where they get their numbers because where I live, food and fuel prices have increased dramatically. Last year the average price for a pound of apples was $1.29 and now the average price is 1.79; that’s an increase of over 38%! The cost of gas has fluctuated over $0.40 within the last 6 months and has now stopped at an all time high where I live.
“But my money will always be there”There is a big misconception from people who keep their money locked away in GICs and other guaranteed investments. They think since their principal investment is secured, that there money will always be there. The problem is the buying power of your money is slowly eroding away thanks to inflation. If your money is only making a return of 1.5% and inflation averages from 2-4%, then your savings will have a reduced buying power down the road.
“Interest Rates Will Go Up”Back in the 80′s interest rates were in the double digits which might seem amazing compared to today’s rates. Unfortunately, inflation rates were even higher (up to 15% at times) which basically negated the benefit of higher interest rates. When interest rates begin to rise, so will inflation and the cost of living along with it. As mortgage rates increase, so do the landlord’s expenses and I’m sure they are going to pass on those costs to everyone else with an increase in rent.
Even if you manage to save millions of dollars for your retirement, it won’t do you a lick of good when the cost of living forces you to spend more of it. When loafs of bread cost $100, and a restaurant outing is in the thousands, your nest egg of millions won’t have the gusto to keep up with inflation.
The SolutionThe truth is that there is no easy, one stop solution. Some might tell you the answer is to clip LOTS of coupons. My personal solution is relying on the old adage ” Don’t put all your eggs in one basket”. Save some of your money in a GIC while putting more money in higher risk investments. I find blue chip dividend paying stocks are the perfect fit for my investment style . You could always invest in *shudder* mutual funds or a better alternative is indexed funds or ETFs. Even rental property can help by providing a passive and inflation indexed rental income. You might have even hit the jackpot with an inflation indexed pension with your job and I highly recommend you do everything in your power to maximize and protect it.
Inflation will not be going away ever, but being aware of its effect on your life is the first step of dealing with it.
How do you plan on dealing with inflation’s effect on your nest egg?
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