Q – I am 36 years old, and I hold a mix of mutual funds and stocks in my investment portfolio. In 2012 I am going to start aggressively planning for my future. I am concerned about the impact of inflation on my investment returns. How do I factor this into my planning strategy? – Dean G., Surrey, British Columbia
A – Inflation is the term for the rate of increase in the price of goods over time. If the price of goods that you purchase every day rises (and it always does) and your earnings or investment returns do not keep pace, then your “purchasing power” has decreased.
Inflation is measured in Canada by the Consumer Price Index (CPI), a representative basket of consumer goods. The Bank of Canada, which is responsible for monetary policy, attempts to keep the inflation rate somewhere between 2% and 3% annually. It even has an Investment Inflation Calculator that calculates the effect of inflation on investments over time. Plug in some numbers and see what happens – it’s an eye-opener.
When it comes to investments, it’s important to factor in inflation, especially if you’re an ultra-conservative investor seeking safety. In November, Canadian CPI grew at an annual rate of 2.9%. A one-year Treasury bill yields about 0.98%. After inflation and taxes, your real return on the supposedly “safe” T-bill after one year would be negative – you will have made no money and you will also have lost purchasing power.
So it’s important to factor in inflation when preparing you financial plan. When you update your plan in the coming years, be sure to readjust the inflation rate you use to be consistent with the Bank of Canada’s target. And you should always target your desired investment return to be greater than the rate of inflation. – R.T.