The upside to inflation
Despite what you might have seen or read or even personally experienced in your own investment portfolio, it’s actually been a decent investing year to date for low-cost indexing fans despite spiking inflation.
So, I wondered, is there an upside to this inflation thing?
The upside to inflation
Inflation continues to be one of those fearmongering, trigger words for many folks but I don’t believe this is something you should really lose too much sleep over…
What is inflation?
At the most basic level, inflation is an increase in the price of goods and services over time. Basically, the ebbs-and-flows of supply and demand in action and those actions can impact you and me.
What does higher inflation mean for you and me?
An erosion of purchasing power…
So inflation is bad, right?
Of course, you could argue some inflation is always very good. The economy is growing.
Better than deflation. Deflation is associated with a shrinking economy and depressed times – less money in supply and therefore less money to spend.
- Inflation will hurt those who have a big bias to cash savings – should inflation continue.
- Retirees focused on just fixed incomes might suffer.
- Borrowers who took on too much variable-rate debt and other large amounts of rolling debt…
- Inflation may benefit those with modest debts who are on fixed repayment plans over variable.
- Owners of land or scarce physical assets (like land, materials, other).
- Firms that can raise prices, rather easily, without too much trouble or public outcry, and more…
While high inflation or spiking inflation near-term is not good for most given the economic uncertainty it presents, the real-life impacts of inflation can vary depending on your age, investment timeline and risk tolerance of course bundled with your debt, assets and other personal finance matters in very different ways.
The Working Class – Asset Accumulators
Beyond higher prices at the grocery store that we continue to see during 2023, I believe higher inflation is an issue for some working class because of the relationship between inflation and unemployment – this has traditionally been an inverse correlation.
Low inflation and full employment are the cornerstones of monetary policy for our central banks. But inflation can cause unemployment since it creates too much uncertainty related to economic growth. Many companies simply struggle to operate effectively during times of uncertainty. They can’t plan.
Assuming you can keep your job (!), on the flipside, one of the best long-term inflation hedges around remains staying invested in the stock market.
While cash is always helpful at any time, a bias to owning stocks with some short-term assets like cash can make for a decent inflation-hedged portfolio.
Stocks can help protect you against long-term inflation while cash can offer a refuge against any short-term inflationary spikes.
The stock market is a wonderful hedge against inflation for a few reasons. Not only have stocks grown in price over time, dividends have grown too. 🙂 So, combined, both appreciation and dividends from stocks offer total returns growing above the rate of inflation.
Aspiring retirees and retirees – Asset Decumulators
Questions related to inflation for this cohort abound:
- Do I have enough to retire, to fight inflation?
- Will I run out of money in retirement?
- How much can I safely spend in retirement?
I have the very same questions…
Many aspiring early retirees (my current situation) or retirees worry about the value of their investments that might not keep up with inflation. Add on long-term, future healthcare costs and there are larger concerns for any retiree to consider.
The good news is in my view, it’s not all doom-and-gloom for this cohort either.
For one, like I mentioned above, stocks offer an inflation hedge. Historically, because companies have been able to pass forward some rising prices back to the consumer, I would simply keep more stocks than bonds and/or cash as you enter retirement and remain in retirement.
Two, make sure you consider specific inflation-hedgers and fighters in your portfolio. Historically speaking, whether you are investing in real estate directly via your home or rental units – owning real estate can at times be a decent hedge for higher inflation. Why? People have to live somewhere…
There is also the energy sector, commodities, industrials and consumer staples to consider owning more of when it comes to fighting inflation.
Here is a decent chart showing returns YTD to September 2023 for some key U.S. sectors. This is not a direct correlation to sector performance for any inflationary period, rather, something to demonstrate how certain sectors have performed differently as part of your own research.
Third, there are some Canadian government beneifts and account features that should be enablers to fighting inflation. Use that information to your advantage. In fact, you already know that both CPP (Canada Pension Plan) and OAS (Old Age Security) have built-in inflation protection.
Every year, tax rates change and to trigger tax rate changes or adjustments to government programs, the government uses inflation data to run the math for a number of programs for the following calendar year.
Here are some examples thanks to inflation that might help you out:
- The TFSA contribution limit will increase a bit from $7,000 (up from $6,500 in 2023). The TFSA lifetime limit for those eligible since 2009 will soon be $95,000 per adult. Incredible.
- The OAS clawback threshold will increase to $90,997 (up from $86,912 in 2023). That means anyone collecting OAS, per adult/retiree, can earn up to $90,997 in taxable income in 2024 without fear of having to repay their benefits. Awesome.
- The federal tax brackets and personal tax credit amounts have increased for 2024 by an indexation factor of 1.047 (a 4.7% increase).
CRA keeps a running list of inflation-adjusted personal taxation and benefits amounts here:
The upside to inflation summary
There is lots to be annoyed about, when it comes to recent inflation spikes. I’m with you.
Yet I firmly believe in your asset accumulation years, where you can, the TFSA in particular remains a government gift to invest in as much as you can. In retirement, the TFSA is a gift that keeps on giving – you can maintain and contribute to this account by funneling any money not needed for expenses to the TFSA for more tax-free growth and/or TFSA estate-building power.
A gentle reminder while contributions to a TFSA are not tax deductible, withdrawals of contributions and growth from the account are tax-free. Contributions to a TFSA can be made in cash or in-kind.
I have no idea how long inflation might last nor what impacts that may cause our broader economy.
I will continue to say and go on record to write that some level of modest inflation is good for both asset accumulators and asset decumulators assuming you continue to focus on things within your financial control:
- Your sustained savings rate.
- Using most of your savings to invest for long-term growth.
- Using some of your savings to protect you from market and/or economic shocks.
- Taking advantage of financial accounts like the TFSA for wealth-building or wealth-preservation, tax-free of course, including from government income-tested benefits.