Inflation, the power it has over us.Mar 15, 2016
Inflation, the mention of the word catapults people back to their days of high school sitting in a classroom while the teacher drones on in a monotone voice about something that as a teenager, you swear is useless information. Now many years later (more years than some of us would like to admit) we are once again forced to think about inflation. It is one of the most important factors to think about when preparing for retirement so we thought we would take a moment to offer a refresher on it.
To put it simply, Sam Ewing said it best:
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.”
Inflation is defined as an increase in the overall price of things over time. It is not the price level of just one item, but rather to how prices of items in several different categories are doing overall. The Consumer Price Index (CPI), which is tied to inflation, is the price for a basket of goods for a certain period of time, such as a month. Price data for the same basket of goods is then compare the prices for the same items from a different time period. The difference between the two is the inflation rate.It is often referred to as the decline of purchasing power, as one dollar does not buy as much in ten years as it does today.
This got us thinking, what are some interesting and weird facts on inflation:
- Hyperinflation (inflation that has gone off the tracks) occurred in Germany in 1920, leading to great social unrest. The purchasing power of money fell so low that the German currency, the Mark, became cheaper than firewood. Hitler blamed the Jews for spiraling inflation, which helped pave the way for the Holocaust.
- In 2008, the top three countries with the highest yearly inflation rates were Zimbabwe (12,563.0%), Burma (35%), and Guinea (23.4%)
- Imagine the prices of everything doubling overnight. That would be tough. Now, imagine that happening day after day, week after week. That's what happened in Hungary in 1946, by far the worst case of inflation on record, when the highest monthly inflation topped out at a daily inflation rate of 195%.
Prices doubled every 15.6 hours, and suddenly people were carrying money around in suitcases and banknotes for groceries.
- In 2008 and with massive loans to pay, Zimbabwe started printing money like it was going out of fashion (which it was about to), putting 21 trillion ZWD (Zimbabwean Dollars) into circulation to pay off its loans. In a few years, it printed another 60 trillion ZWD to pay the salaries of soldiers and government workers. The effects were devastating to the economy. In one month, inflation hit a record high with prices doubling every 24 hours. A loaf of bread cost $35 million ZWD. And by April of 2008, the $50 million ZWD note was worth a little over one US dollar. They were printing so much money, they ran out of paper. The country was full of trillionaires and almost all of them were struggling to survive.
- A McDonald’s hamburger cost $0.25 in 1972 and that same burger costs $1.48 but the recipe hasn’t changed and efficiencies have increased. Interesting.
What are Canada’s historical inflation rates? Let’s just say much better some of the other countries we just mentioned.
How does inflation affect you in retirement?
You have several options available to combat inflation. First, rates of return need to be higher than inflation. For example, if you have your retirement savings in a GIC receiving 2% rate of return and inflation is at 2.4%, you are in reality are losing 0.4% on your investment. This is known as the Real Rate of Return (rate of return – inflation = real rate of return). As an investor, you must look at your real rate of return. Unfortunately, investors often look only at the nominal return and forget about their purchasing power altogether.
Secondly, if you are relying on fixed-income in retirement such as a pension or annuity, you are at the highest risk to inflation impact. However, there are ways to mitigate this by choosing an annuity with the option to have your income adjusted to the current inflation rate. Over a long period of time, this is vitally important. If you are in a defined benefit pension plan, look at your plan and check if it is adjusted for inflation. If not, talk to your financial advisor for help on compensating for this. There are a variety of strategies that can be leveraged in order to better insulate your retirement income against the negative impacts of inflation.
Thirdly, remain invested even during retirement. While you should gradually move to a more conservative portfolio as you approach and enter retirement, it’s important to select a mix of investments likely to keep pace with inflation. Bonds, GIC’s, money market funds, and bank savings accounts alone, which are generally considered relatively safe places to put your money, may not provide enough growth to outpace inflation. Consider incorporating stocks and other investment types, as well, to add a prudent level of growth potential to your portfolio.
Want to find out more? We have pulled together some links to other great resources:
- The Khan Academy has a great video that simply illustrates what inflation is. Click here to watch it.
- Want to know what the current inflation rate is for Canada? Click here to find out.
- See for yourself how much inflation has affected things over tim by clicking here to try the calculator.
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Savanti is your no-nonsense, get it done, always got your back, tell it to you straight, make you laugh, and there if you need to cry - financial partner.