For years, after the Great Financial Crisis (GFC), inflation stayed low – until now.
Are there ways to take advantage of inflation?
Is some inflation good?
How might you invest as inflation roars ahead?
Read on to learn about our takes, what we’re doing, and why.
Understanding inflation and inflation in context
Generally speaking, inflation is the general rise in prices over a specific period of time.
This monetary policy was set in the early 1990s when the Bank of Canada and the Minister of Finance agreed on an inflation-control target framework to guide Canadian monetary policy. The target agreement has been renewed several times since per se, but generally speaking, 2% was targeted because it supports “a strong and inclusive labour market” that provides every Canadian with opportunities for a good quality of life.
How times have changed.
But we’ve been here before folks…
Inflation has fluctuated quite a bit over the course of history.
In fact, during the 1970s and 1980s, prices increased from 10% to 15% in some years.
In the 2000s, inflation rates fluctuated between 2% and 5%.
In the 2010s, inflation hovered just between 0% and 2%.
In some respects, what is old is new again and when it comes to recent history, in fact, times have been cheap.
Why inflation matters
Over the past decade until now, disciplined investors have enjoyed an uncharacteristic world of low inflation and very-low interest rates.
Low, stable and predictable inflation is can be good for the economy and for investors – it helps money/cash keep its modest value, it makes like easier to plan for, and it makes everyone else around us somewhat predictable when it comes to money management. That might explain why the bull market was so long, and so powerful, after the GFC. Everything was somewhat, predictable. Everything went up.
Companies are more likely to grow their business when they know what their costs will be in the years ahead. This helps the economy expand at a sustainable pace, generating higher incomes and new jobs. Prices tend to go up when the demand for goods and services is more than the economy supplies. Prices tend to go down when the economy supplies more goods and services than people want or need.
When prices change so slowly that they don’t affect how people spend, save or invest, this creates price stability.
However, when prices go up, sometimes sharply, money just doesn’t cover as much as it used to. You can’t buy as much as you’re used to. There is a loss of purchasing power. Your standard of living starts to cause concern.
Worse still, when inflation is high, consumers, businesses and investors become uncertain about what comes next. This creates price instability. High or spiking inflation creates an unpredictable climate.
Like right now.
To measure inflation, a reminder our Bank of Canada focuses on the consumer price index (CPI). While the CPI is not a perfect measure, it does serve a purpose.
If nothing else right now, with inflation running hotter, you would be wise to ensure your assets are properly diversified since there are some great benefits to take advantage of.
Inflation isn’t all bad…
Before we get into how to take advantage of inflation, here are our takeaways to date.
- Inflation will hurt those who have too much cash bias – although some cash is always good!
- Retirees focused on just fixed incomes might suffer – consider more equities – see below!
- Borrowers who took on variable rates will suffer – so reduce your debt folks!
- Inflation will benefit those who have fixed debt payments over variable debt.
- Owners of land or scarce physical assets (like land, materials, others) are likely to benefit.
- Firms that can raise prices, rather easily, without too much trouble or public outcry are likely to thrive. Let’s unpack that!
How you can take advantage of inflation
Knowing that interest rates to help combat inflation, are likely to rise from our Bank of Canada slowly over time, here are some of our favourite ways you can take advantage of inflation – and what we’re doing about it.
1. Kill your mortgage debt and keep owning real estate
Over the past decade, long-term investors and retirees have been spoiled because the threat of higher inflation or higher interest rates to combat inflation has been almost non-existent. Well, with inflation here, if you haven’t already come up with a game plan for inflation – consider killing off debt and keeping your real estate assets.
Home prices have only been going in one direction in recent years. A home/your home or other real estate assets financed with a low-fixed rate mortgage should help you navigate inflation well. Even if home prices correct 10%, as high as real estate prices have been, you can insulate yourself a bit since real estate is an asset class unto itself. I mean, you and others have to live somewhere…
2. Seek value in value stocks and pounce on growth stocks
We fully believe in history: rising inflation can be a headwind for equities. But history also says some equity sectors are better at combating inflation than others.
Sectors that do well during higher inflationary regimes are ones that can mitigate rising input costs by passing on the higher prices to consumers. The energy sector stands out in this category. That makes investing in Canada’s home bias to some energy sector companies a smart play. Furthermore, since monetary policy in Canada is linked to combating higher inflation, financials could benefit. Recall 40-50% of Canada’s top-60 performing companies are historically banks, life insurance companies and energy companies. Do with that information what you will!
- Here is a link to low-cost ETF XIU to prove our point.
- It’s one of our favourite ETFs to build a low-cost diversified portfolio with.
At Cashflows & Portfolios, we would also argue that consumer staples stocks (largely from the U.S.) are also likely to benefit from higher inflation since demand is always there.
Sectors such as the technology sectors, in particular, tend to get hammered in higher inflationary climates since many technology companies have high growth potential but low current earnings and cash flows. When the cash flows are forecasted in the distant future, which may or may not be generated or legitimized today, that tends to lead to lower (current) valuation or expectation of the company = lower prices. As such, as the tech sector continues to get pummelled, this might be a time to consider buying some of the top U.S. tech stocks in the S&P 500 since prices for those companies in any bear market are essentially on sale.
Based on our experiences including the current inflationary pressures, we’re personally invested in the following sectors to help take advantage of inflation:
- Energy stocks
- Consumer staples
- Buying individual tech stocks or tech stocks via a low-cost index fund when it makes sense!
3. Get guarantees from fixed income investing
For sure you can invest in real return bonds if you wish (note: a real return bond (RRB) is a bond issued by the Government of Canada (GoC) and/or certain provincial governments that pay you a rate of return that is adjusted for inflation) but such coupon/interest payments from bonds are not really guaranteed.
Further still, RRBs only protect against inflation but not a rising rate environment.
We believe rising rates will do more damage to the investment product than the benefit of inflation protection.
So, what is an investor to do?
And the benefits of owning GICs for short-term savings are getting better and better with higher interest rates.
When investing in bonds, remember that any investor may be seeking protection from certain risks, such as market volatility or inflation. However, investors are also taking on risks with bonds they don’t always understand: risks associated with liquidity, credit, or interest rate/duration risk.
RRBs in particular is interesting in that interest payments are pegged to CPI. The big risk associated with investing in real return bonds is the interest rate/duration risk, as these bonds have a fairly long duration. We did some quick research: some RRBs had a duration of about 15 years! You need to know when it comes to longer durations, bonds tend to underperform when yields are rising.
We believe a far better way to invest, to lock up money for 1 or 2-years, is using a GIC.
While GIC rates change often, make sure you check out our popular post about the Best GIC Rates in Canada.
That post will link you to the best GIC providers in Canada to guarantee your interest payments as interest rates move higher to fight inflation.
How you can take advantage of inflation summary
Higher inflation and higher interest rates can be headwinds for equity investors. But some sectors are better positioned for both environments – so best be paying attention now.
Since the GFC, we believe investors, retirees, and people borrowing colossal amounts of money (taking on leverage) have been spoiled. For several years, inflation never rose above 2%!
But in recent months, inflation is making a comeback and inflation and rates are coming home to roost!
Federal Reserve Chair Jerome Powell, in the U.S., has emphasized his resolve to get inflation down to a “healthy level”. The same desire applies here in Canada. If they mean what they say, (we’ll see…) that means central banks are likely to move rates at least 200 basis points (or about 2%) higher in the coming year or so to get inflation under control.
Higher inflation and higher interest rates to combat inflation aren’t all bad if you continue to pay attention and take advantage of the situation.
We continue to stay invested ourselves, we continue to have a diversified portfolio of dividend-paying stocks and low-cost indexed funds while we stay invested, and we’ve been tilting our respective portfolios towards energy, financials, REITs, commodities and a few other sectors to take advantage of the current climate.
We keep some cash on the sidelines to make strategic purchases and we think you should too.
In general, inflationary periods present any wise investor with a great opportunity: to revisit your financial situation and make some adjustments. This way, you’re always well-positioned for whatever may lie ahead.
How are you working through higher inflation and soon-to-be higher interest rates?
What’s your game plan? Share in a comment or become a member to chat in our membership forum!
- Should you use or consider an all-weather portfolio for higher inflation?
- With higher inflation and costs, you might want to consider working part-time in retirement or consider semi-retirement. This is how a part-time job can save your retirement plan.
- Keep more of your money in retirement. Here are some top tax tips for retirees.
- With interest rates rising, more people are looking at GICs. Here’s a calculator to help you get the most out of your GIC or savings coverage offered by the Canada Deposit Insurance Corp.
Improve your retirement readiness at a low cost by becoming a member!
Everyone has a different path on their asset accumulation journey, and fighting inflation to some degree.
At Cashflows & Portfolios, even though we both own 7-figure investment portfolios now, we’ve built our respective portfolios similarly but also differently.
The common denominator on our retirement readiness path are these tactics (and more) to fight inflation and take advantage of higher inflation over time – it’s here and will be here for some time.
We can also help you out with any burning retirement questions that include the impacts of inflation related to:
- What registered accounts do you draw down first, to avoid inflation or taxation bites?
- How much income will your investments generate to overcome inflation?
- Do you have any idea how long your income might last, with higher inflation? We can help!
- Is it more beneficial to draw down any non-registered money before RRSPs before TFSAs? (Hint: Yes!)
- And much, much more…
If you are interested in obtaining private retirement projections for your financial scenario, please contact us here to get started.
Stay tuned for more, great, FREE content on our site. We’re happy to help.
Mark and Joe.