Dale Jackson

Personal Finance Columnist, Payback Time

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When it comes to personal finance there are things we can control and there are things that are beyond our control.

We can earn extra income, budget spending, and choose investments for retirement, but our best plans could be undermined by inflation.

Inflation has the potential to wash over everything we have accumulated like a tsunami, but there are ways to prepare and blunt the impact of whatever comes.

Most of us have already experienced inflation at grocery stores and gas pumps. However, the degree or longevity of inflation headed our way is not certain. Economists blame the disruption of the supply chain due to pandemic-induced lockdowns for pockets of inflation saying they are “transitory”, or temporary, and will work themselves out. One analogy is a snake digesting a softball. The rapid rise and fall of lumber prices is a perfect example of transitory inflation.
 

GET DEBT UNDER CONTROL

The Bank of Canada reassured Canadians this week that it has the monetary tools to keep inflation under control. The most effective monetary tool for most central banks is the ability to cool the economy by raising their benchmark interest rates, or lowering them again if the degree of the increase is stifling the economy.

Higher interest rates mean an increase in borrowing rates for consumers, who are currently holding record amounts of debt. Paying down debt while rates are still low provides more bang for the buck because a greater portion of those funds reduces the principal instead of channelling interest to the banks.

The Bank of Canada could also lean toward raising rates to cool the red-hot housing market. Higher mortgage rates could drastically increase regular payments for homeowners with variable-rate mortgages.

If you can’t pay down your debt faster, now is the time to lock into a fixed rate. The going five-year fixed mortgage rate of 2.3 per cent is more of a short-term burden than the going variable rate of one per cent, but fixed-rate borrowers can rest easy when variable rates move up.

If you have other variable rate debt, such as a student or car loan, talk to your bank about moving it to a fixed term.
 

INFLATION-PROOF YOUR INVESTMENTS

Defined-benefit employer pensions, the Canada Pension Plan (CPP), and Old Age Security (OAS) are indexed to inflation, so benefits will automatically be adjusted to the cost of living.

Unfortunately, most Canadians save for retirement through defined-contribution pensions and registered retirement savings plans (RRSPs), which are normally a portfolio of individual investments not indexed to inflation.

That means growth of six per cent annually, as an example, is two per cent if inflation hits four per cent. For many Canadians, two per cent growth will not get them to their retirement goals.

It’s best to speak with a qualified investment advisor about the best ways to hedge against inflation. Generally, it’s safest to stay diversified in equities because inflation goes hand-in-hand with strong corporate earnings, which are often reflected in higher stock prices.

Diversification across geographic regions and sectors is also a good hedge because it’s difficult to predict which areas of the equity markets will be hardest hit - or do well - in an inflationary environment. 

Prices for commodities like crude oil, natural gas, grain and metals tend to track inflation closely. You can invest in specific commodities on the futures market through exchange-traded funds (ETFs), or purchase shares in commodity-producing companies directly, or through ETFs or mutual funds.

Real estate is another equity asset class already contributing to - and benefitting from - inflation. Homeowners are reaping rewards from soaring residential real estate prices but there are many ways to diversify real estate holdings into other real estate sub-sectors through Real Estate Investment Trusts (REIT). REITs are companies that own and operate residential, commercial, and industrial real estate that generate income from rents and capital gains through price appreciation.