Imagine needing a wheelbarrow of cash to buy a loaf of bread. That was the scene in 1919-1923 Weimar Germany because of hyperinflation, to the tune of 21% ... daily. While that’s an extreme case, inflation is an important concern for Canadian investors, especially as it’s been creeping up recently and is now over 2%.
Inflation is a sustained increase in prices for goods and services that erodes your purchasing power. It’s the reason penny candies don’t actually cost a penny. When the supply of goods and services is low, as in the case of a natural disaster or a conflict, supplies become scarce, and consumers are willing to pay more for them. When demand is high for goods and services, as in the case of rising wages or income tax cuts, prices rise. Face the perfect storm of falling supply and rising demand, and the Bank of Canada might bring back the thousand-dollar bill.
How does it affect investors?
When the inflationary tide is rising, you want your portfolio to rise with it. Unfortunately, traditional fixed-income products act more like anchors in an inflationary environment. Bonds, GICs and the like can play an important role in your portfolio because of their low volatility and predictable income, but they are vulnerable to rising prices. Say you’ve locked into a bond that provides a monthly payment of $500 for the next 20 years. After only five years at an annual inflation rate of 7%, the purchasing power of $500 would be closer to $356.
Fortunately, there are assets that, as a rule, fare better in times of high inflation. Here are some ways to inflation-proof your portfolio that, depending on your situation, may be right for you:
- Commodities such as gold, oil, copper, wheat, etc.: Gold has traditionally been seen as a store of value during inflationary times, with its relative rarity yet broad acceptance as an unofficial currency underpinning its value. And, the world relies on fuel and food; thus, there will always be a demand for some commodities, no matter the cost. You can gain exposure in your portfolio through shares, futures contracts or Exchange-Traded Funds (ETFs).
- Real Return Bonds (RRBs): The value of existing fixed-rate bonds dives in times of high inflation. However, Real Return Bond payments are inflation-indexed – when inflation rises, so do RRB payments.
- Indexed life annuities: A life annuity is a contract that binds an issuer to deliver a steady stream of income payments that last an entire lifetime in return for a lump sum deposit. Under an indexed option, your payments may be indexed each year to a cost of living index so you don’t lose your purchasing power.
- Shares of essential services companies: Generally, inflation raises companies’ costs faster than companies can pass the price increases off onto consumers. That said, some industries can increase their prices faster than others, such as utilities and consumer staples.
- Real Estate Income Trusts (REITs): Mark Twain had biting wit as well as prudent hedging advice: “Buy land, they’re not making it anymore.” You can gain exposure by investing in REITs, which own various income-producing properties.
Over the past 40 years, the Bank of Canada has helped keep inflation at 1-3%. But before that, there was a time when it spiked to over 12.5%. It’s important to consider the risks of inflation as they can be curbed with the right plan and a diversified portfolio.
For more information about inflation-proofing your portfolio, please contact us today.