The chatter in the system is that inflation is coming.
Hardly surprising. I would venture to say that inflation is already here. Groceries are more expensive than they were a year ago. Gas prices have risen in my corner of the world. Friends who need lumber are sharing horror stories about the price. There’s not a doubt in my mind that inflation has arrived…and it’s going to get worse before it gets better.
I’m going to suggest that you invest to beat inflation.
First of all, you need to know that I’m not an economist. I am not in any way certified to give you an opinion on how to invest. I know what has worked for me in my circumstances. There are no guarantees that my strategy will work for you in yours.
Secondly, I’ve been around long enough to know that paycheques don’t rise in line with the increased cost of living. It sure would be nice if they did, but they don’t. Your take-home pay will stay the same even though the prices of what you want to buy will continue to go up. In other words, your paycheque has to stretch farther just so you can continue to live way you want. This is inflation at work.
There are several ways to fix this. You could get a raise, or find a higher paying job. Great. If your employer chooses to pay you more money, then pat yourself on the back. Keep in mind that there’s no reason for your boss to give you a raise if she doesn’t want to. I mean, you could be replaced, right? And maybe the next person would do your job for less money… Trust me – this thought may have crossed your boss’ mind a time or two.
If a raise isn’t an option that your employer is willing to pursue, then you can always search for a higher paying job. Should you be lucky enough to find one, hooray! The higher take-home pay can now go towards paying higher purchase prices for all those things that are more expensive today than they were yesterday.
A third, less palatable option to combat inflation, is to cut out all the things that are now too expensive for your still-the-same-size-paycheque. That might mean giving up your gym membership, extracurricular/educational courses, cable, streaming services, books. You might have to move in with roommates, or stop eating out, or give up buying new clothes. There are many ways to cut back, but you can only cut back so much. There comes a point where there’s no more fat to trim.
I don’t want you to get to that point.
What I want is for you to invest to beat inflation.
How does that work, Blue Lobster?
Investing in equities over the long-term results in returns that are higher than the rate of inflation. Equities is a fancy way of referring to the stock market.
You cannot invest in GICs at the bank that only pay you 1.6% and expect to beat inflation. For one thing, inflation may be higher than 1.6%. Secondly, interest is fully taxable at your marginal tax rate. If your marginal tax rate is 27%, then you’re not earning 1.6% on that GIC. You’re only earning 1.168% (= 1.6% x [1-0.27]). Thirdly, GICs lock up your money for atleast a year. The main benefit of GICs is safety. Unfortunately, the cost of safety is too high because your money will be ravaged by inflation. You will effectively be falling further behind financially since you’re only keeping 1.168% of your GIC’s return while inflation is increasing prices by 1.7%.
Investment returns > inflation rate. Good.
Inflation rate > investment returns. Bad.
To avoid the second scenario, invest in the stock market through diversified equity-based exchange traded funds and/or index funds. Consistently save and invest your money into stocks via these investment vehicles then leave it alone to grow. Do not check it every day. The stock market is volatile. In other words, the value of your account will go up and down but the trend over the long term will be upward. If volatility bothers you, then the answer is to not check your investments every day. Avoiding the stock market is most definitely not the solution to your aversion to the unpredictable nature of the stock market.
Stuff money into your TFSA and RRSP and buy equity-based ETFs and index funds. It might take you a few weeks to max out your contribution room. It might take you a few years. That doesn’t matter too much. The important thing is to start today. Get your money working for you immediately. Once you’ve maxed out your registered investment accounts, then keep investing your money in your brokerage account, aka: your non-registered investment account.
How do my investments beat inflation, Blue Lobster?
Over the long term, your investments will earn a return that is higher than inflation. Your registered investments will have the added benefit of doing so without being ravaged by taxes.
For example, assume that inflation is at 1.5% and your investments return 10% over the long term. Also assume that your tax rate is 27%. Your registered investments will be beating inflation by a rate of 8.5% (= 10%-1.5%). Remember! The money that is earned inside your TFSA and your RRSP grows tax-free so you need not concern yourself with your tax rate.
Money earned outside of the shelter of your TFSA and your RRSP is subject to tax. For this reason, you’ll still be beating inflation in your investment account but not by the same amount. The money earned in your non-registered investment account will be beating inflation by 6.205% (= [10%-1.5%] x [1-0.27]).
Disciplining yourself to stomach the volatility of the stock market will be very profitable for you. When the time comes to start living off your investments, they will have grown nicely. Your investments will be more than ample to cover the inflation adjusted costs of living. Ask your grandparents if, when they were in their 20s and 30s, they’d ever imagined a brand new car costing $35,000. Ask your parents if they’d ever thought people would pay $5 for a cup of coffee. Now imagine yourself 35 years from now at the grocery store and realizing that the price of a single loaf of store-brand bread is $9.
By investing in equities today, you will be taking a big step towards outpacing inflation. Start today by taking the following steps:
- Open a TFSA, an RRSP, or a brokerage account.
- Every time you’re paid, have a pre-determined chunk of your paycheque sent to your investment account. Do this by setting up an automatic transfer from your chequing account to your investment account, ie. TFSA, RRSP or brokerage account.
- Leave the investment account alone to do its job.
- If available, participate in the dividend re-investment plan. You won’t be spending the dividends. Instead, they will continue to be re-invested for the long haul.
- Rest a little bit easier knowing that the long-term average return on your investments is higher than inflation.
You can take steps today to mitigate inflation’s impact on your life tomorrow. Just do it!