Rising interest rates are alarming most Canadians. All in the name of fighting inflation. Some can accept rising prices but when it comes to servicing mortgages and debt, this is most concerning for people. Especially with mortgages and debt related to the high values people have paid in recent years. Rising inflation is forcing some advisors, such as us, to have difficult conversations with clients about their spending habits and whether they should make adjustments to their financial life plans.
The inflation and interest rate landscapes are shifting dramatically. Rising costs could be more persistent than most initially thought and interest rate hikes are coming sooner and faster than forecast. For investors, it’s worth dusting off the old inflationary playbook and giving it a closer look.
In turn, many Canadians are paying closer attention to the latest inflation readings and reaching out to advisors for guidance and comfort that their portfolios can withstand a higher cost of living. It’s the most we’ve ever talked about inflation with clients especially after recent news that Canada’s annual inflation rate jumped to 7.6% in May the highest in fourty years. It’s becoming exponential hence the Bank of Canada hiking the prime rate as quickly as it is, including 1% last week. It’s a scary number, especially after years of it being relatively flat.
Financial life plans we have created for clients have traditionally been on the conservative side, with inflation projections of about 2.5 to 3.5%. Still, clients are concerned about how rising costs and interest rates could eat into their savings and affect their lifestyles. It’s certainly difficult for some people particularly those with more fixed income and cash flow. That’s the reason people come to us. To look for some support.
Our advice to our clients is to review their cash flows and see what adjustments may be needed. We also remind people that some inflationary pressure could be temporary, such as on goods like cars and computers that are caught up in the current global supply chain crunch.
Emotional impact
Advisors need to focus on the emotional as well as the financial impacts rising costs could have on their clients. They should contact those who may be most vulnerable, including seniors on a fixed income and working people living close to break-even, first.
The age of the client could also have an impact on how they react to rising costs. Clients who express inflation concerns are primarily those who had mortgages and children in the 1970s and early 1980s when inflation hit double digits. It was a very difficult time for them. The word inflation has a different meaning to them. To those clients, if appropriate, making any necessary spending adjustments to maintain a strong fiscal position is important. The key is to not overreact.
More investment risk
The other concern for retirees, in particular, is the temptation to take on more investment risk to generate higher returns. It’s important to proceed with caution here. It could work out, or it could be disastrous, particularly because rising interest rates often precede economic recessions which can lead to significant stock market declines.
Meanwhile, younger generations who haven’t lived through high inflationary times may not appreciate the negative implications. For them, it’s about education and encouraging them to focus on income growth to keep up with or grow faster than inflation.
Discretionary expenditures
One thing we advise clients on is to consider putting off purchasing items for which inflation is likely to be temporary, such as buying a new or used vehicle. Car and truck costs have surged amid a global microchip shortage and supply chain issues that may be worked out in the months ahead. You just don’t want to get caught up in a supply-demand squeeze.
It’s the same advice that we offered earlier this year when people wanted to build decks on their homes as lumber prices were skyrocketing; they’ve since settled down.
On the other hand, costs like groceries and restaurant meals aren’t likely to drop materially, overall. Food pricing is stickier than discretionary product categories. Housing is also expected to remain extremely expensive, either buying or renting. Even if housing and grocery bills stabilized from here, they’re still elevated. You have to plan for how you’re going to accommodate these changes in your in your cost of living.
Inflation assumptions
People getting close to retirement age may wish to reconsider when they take their Canada Pension Plan (CPP) and Old Age Security benefits as a way to tackle inflationary pressures. For example, pointing to numbers shows that Canadians would receive 36% less in CPP benefits if they took them immediately when eligible, at age 60, instead of waiting until age 65. Canadians can also choose to wait and receive 8.4% more each year versus retiring at 65. Up to a maximum of 42% more if they take CPP at age 70. It can help with your inflation-adjusted income and that longevity risk.
We also review, with clients, what inflation assumptions are being used in their financial life plans. In meetings with prospective clients, we’ve come across financial plans containing inappropriate inflation assumptions based on the industry suggested guideline of 2%. You need to make sure that the assumptions used in the financial plan are in line or even more conservative.
The bottomline
Advisors should also help clients ensure they’re personalizing their financial goals regardless of rising prices. She says some people may be willing to pay extra for products and services that are important to them. People should really focus on their own goals and say: How am I spending? What spending allows me to live my best life?
One of the best things that we can do with personal finance is get away from this idea that there are rules that people should follow, and lifestyles that people should lead, and get really a lot more focused on what’s actually going to make them happy. That’s the real key to Keeping Life Current.
