Covid has introduced some changes to the way we consider investing. Supply shortages and lulls in manufacturing have triggered an increase in inflation. Canadian savers have long been dogged by low interest rates on low-risk investments like guaranteed investment certificates (GICs) and bonds. At least inflation, which erodes the purchasing power of money, used to be low as well.
With the price of anything from food to gasoline soaring in recent months, that’s no longer the case. Canada’s inflation rate reached 4.4 per cent in September, the highest it’s been since 2003. Meanwhile, the Bank of Canada has yet to raise its trend-setting interest rate.
With investors now caught between the rock of rising inflation and the hard place of still-low interest rates, what, if anything, Canadians can do to protect their savings.
Continue to keep some savings in cash
If you’re feeling the urge to move some or all of your spare cash into higher-yielding investments to help thwart the impact inflation is having on your finances, resist that impulse. I’m a big advocate of having cash on hand. Your emergency fund and anything you’re saving for, short-term goals with a time horizon of two years or less, should stay in cash
While you can get greater returns in the stock market, there’s still a lot more volatility and a lot more risk. The point of having cash savings is to protect yourself in emergencies and to save for a short-term goal without exposing yourself to that risk and volatility.
In general, it’s important to put the current bout of inflation into context. While the current rate of inflation is higher than what Canadians have become used to over the past several years, it’s still not all that high. One of the most important things people can do is not stress about it too much.
If you’re determined to squeeze a little extra out of your cash savings, you check whether you could get a higher interest rate on your deposits through a savings account offered by a credit union or an online bank. But don’t hold your breath. In the current low-interest environment, even the most competitive high-interest savings account aren’t paying much.
Maybe hold off on GICs
While it’s a good idea to keep at least some of your savings in cash, you may want to hold off on locking into a GIC right now. With a GIC, you lend your financial institution your money for a set number of months or years. Your principal is guaranteed and you’ll usually earn a fixed interest rate on your deposit. However, for some GICs you’ll have to pay a penalty if you withdraw your money before your term is over. And GIC rates aren’t much higher than what you might get with a high-interest savings account.
At current interest rates right now, I think GICs are probably one of the least attractive investments out there. If we get a rate raise, you don’t want your money trapped in a GIC, waiting for the term to end and missing out on the increased interest rate.
The Bank of Canada said on October 27th it is holding its key interest rate at 0.25 percent, where it has been since March of 2020. But analysts expect the central bank to start gradually hiking rates starting as soon as the second quarter of 2022.
Inflation isn’t a good reason to change your asset allocation
If you’re wondering whether you should shuffle your portfolio to take on riskier investments and chase higher returns, take a breath. When averaged out over a very long period of time, the rate of inflation in both Canada and the US is around three percent. On both sides of the border, stock returns have significantly outpaced that rate, with bond returns also significantly higher.
I don’t think people need to start thinking about doing anything special to try and combat the current rate of inflation.
Also be leery of investing in cryptocurrencies as a way to hedge against inflation. Crypto is sold as an inflation hedge because of its decentralized nature, because it’s not tied to fiat money. A hedge is an investment whose price movements help offset the impact of whatever an investor is hedging against. If cryptocurrencies were an inflation hedge, you’d expect their value to increase when inflation rises. The reality is the crypto is extremely volatile and something that volatile. It’s really tricky to call it a hedge.
In general, inflation isn’t a good reason to change the mix of stocks, bonds and other types of investments in your portfolio. You shouldn’t change your asset allocation necessarily based on what the market is doing, it should reflect your risk tolerance based on who you are as an investor and the age that you are.
Take a hard look at your investment fees
Overall, the best thing you might be able to do for your portfolio right now is reduce the investing fees you’re paying. Reducing your fees is a guaranteed savings. Cutting fees is one of the best ways to increase your expected returns. Fees are what you pay the financial service providers that enable you to invest in the financial markets and they can vary significantly. The fees reduce the net return your receive from your investments.
That said, don’t obsess over fees. The downfall is that in the chase for lower fees, one sacrifices investment expertise on what to invest in given the intended use of your funds and your risk tolerance. Lower fees can result in access to professional investment advice. If you are not savvy at making appropriate investment choices, then the chase for lower fees can actually increase the risk associated with the decisions you are making.
The fees associate with working with an investment adviser over time can be addressed by the rates of return your investment portfolio is providing. Paying 0.25 percent on an ETF that returns 4 percent is certainly bested by an equity fund parking 8 percent with a fee of 2.5 percent.
The bottomline
Inflation is a natural variable in your economy. It will increase and decrease over time dependent on the state of the economy and the markets. There are a lot of inflation influencers. We should not act on impulses or fear in making investment decisions. Prudent advisers will advice you to hold ground with a well-diversified portfolio.
That is one of the many benefits of working with an adviser. Sure there a higher fee but the return will certainly exceed what you may experience as an uninformed investor going it alone is volatile market. A patient and established investment strategy that tolerates the impact of growing inflation is the proper perspective for Keeping Life Current.
