Be prepared for rising inflation
Forget the published numbers on inflation. If you really want to know what’s going to happen to your own standard of living, simply look around you.
Although Canada's inflation rate recently slid to its lowest level in almost two years, nobody really thinks it's going to stay there.
Job outsourcing has dampened inflation here in North America, thanks largely to low wage rates in newly industrialized countries. As wages rise there, however, these increases will filter through to goods and services consumed here.
While higher inflation won't strike overnight - it may even be a couple of years away — some analysts believe it could be significant when it does hit.
"We expect global inflation over the next three to five years — or even the next five to 10 years — to be higher than it has been over the last 20 years," says Mihir Worah, head of real-return strategies at bond-investing giant PIMCO.
"While we don't expect double-digit inflation, we do see inflation gradually climbing higher than the close-to-two per cent core numbers that we have gotten used to in much of the developed world," he adds.
Should you be concerned? I'd say yes. Everyone feels the pinch of rising prices. And the older you are, the higher the level of apprehension.
Sure, retirees' indexed government retirement benefits and — for some at least — pension plans will help keep their purchasing power intact over time. However, inflation is a real worry for an increasing number of Canadians.
As a result, some advisors are beginning to employ higher rates of inflation in their projections for clients' future income and expenditures, particularly since the Consumer Price Index, the most common measure used for changes in inflation, simply doesn't reflect day-to-day reality for many people.
The CPI measures price changes for a basket of goods and services, based on average spending by Canadians in a particular year. But there can be large differences in the price increases for these expenditures.
In fact, you could say that every person has his or her own individual inflation rate.
For instance, about one-third of the typical family budget is dedicated to keeping a roof over your head, but whether you rent or own makes a huge difference in where inflation hits you most.
It's all about spending patterns. Younger people tend to spend more on electronics, kids' toys or school costs, for example, while older people will normally use up a greater percentage of their income on essentials like food, utilities and — as they age — medical care.
And people of any age who drive a lot will clearly be more worried about changes in the price of gas. But not if they can take the subway instead, an option that's unavailable to those outside major urban centres.
It all adds up. The costs of operating a car, for instance, have increased at a much faster pace than the CPI over the past decade — including increases of about 80 per cent for gas and something like 60 per cent for insurance premiums.
The good news is that serious inflation, and the rising interest rates that will accompany it, is still far enough away that you have some time to do something about it.
It's always a good idea to pay off your debts as soon as possible anyway, but if you're holding any kind of credit card debt, this would be a good time to get serious. The same goes for a home equity loan that "floats" with the prime rate.
If and when inflation rises, these costs will quickly go up. If you do have to borrow, and that means a mortgage for most people, go long and stretch things out.
For instance, if you think inflation is accelerating and mortgage rates are going to be higher than about 4.5 per cent in five years, then you should at least consider locking in for the 10-year term.
On the portfolio side, the easiest way for investors to set up an inflation hedge is to buy a real estate investment trust (REIT) or a fund holding a basket of these securities that generate much of their income from rents that are likely to rise with inflation.
The prices of many REITs have risen sharply, though they could pull back a bit if the economy slows and interest rates rise.
Ideally, you want these inflation-fighting assets to be widely diversified, so it's best to invest through mutual funds like Sentry REIT Fund (I own units of this fund) and exchange traded offerings, such as BMO Equal Weight REITs Index ETF.
PIMCO also recommends looking closely at inflation-linked bonds, such as Treasury inflation-protected securities (TIPS) in the U.S. or real-return bonds here in Canada.
The rate of return on these securities, while modest right now, is adjusted for inflation, effectively removing that risk at least.
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