Recently, the Bank of Canada said that inflation (rise in general price level) “has been running at a rate of close to 4% the last few months…and is expected to near 5% by the end of 2021”, reaching levels that have not been seen since the early 90’s.
I’m sure without even seeing these numbers, we can all agree that the impact has been felt in many aspects of our daily lives this year – whether that be groceries, gas, or living costs. While we experience this every day, the true value of money is illusive and many people often don’t realize the impact inflation has on their savings or fixed income investments.
Take Guaranteed Investment Certificates (GIC’s) for example. Traditionally, GICs were marketed by banks as “risk-free” investments. Today, we argue that they are actually quite the opposite.
We read a story earlier this year (by Advisors Edge) of a man who went into the bank to invest. The bank went through the normal procedure of determining his risk tolerance, then said “how about your put this money into a GIC?”. The man asked “What’s the rate of return?” The bank said 1.6%. The man asked, “What’s the rate of inflation?” and the bank replied 2.8%. So, the man said “Are you advising me to lose my money?”
When we think of money, we often think of it in ‘nominal’ and not ‘real’ terms. Another way to say this is we think of $1 as $1… not as how much $1 can buy us that day. Consider;
As of writing this, most 3–5-year GIC’s from Canadian Banks are “guaranteeing” around 1% interest per year. Naturally, most GIC owners feel they are invested ‘risk-free’ as they are guaranteed their capital back plus interest. This is true in ‘nominal’ terms. However, in ‘real’ terms, the investors are actually exposing themselves to a significant amount of risk especially in 2021.
|GIC Return||Rate of Inflation||‘Real’ Return on Investment|
If their GIC generates 1% interest, and inflation is running at 4%, then the real return is negative 3%. That means you will continue to lose purchasing power for as long as your investments return less than the rate of inflation… hardly a recipe for sustained success. We should point out that this doesn’t even account for income taxes, but we’ll leave that discussion for next time.
Remember, there is no such thing as risk free. Although you may be able to protect your investments from temporarily falling, there are other types of risk that are important when planning your future, like inflation. That is why any investment plan has to include equities for long-term growth. For more reading on that – Click here to read “Equities Are In For the Long Run”.
The greatest long-term threat to investors is not short-term market drops, but the risk of running out of ‘real’ money due to inflation and longer life spans. With interest rates at historic lows, we concentrate on positioning our clients in the diversified portfolios they need to preserve purchasing power and outpace inflation.
We always love to hear from you, so please don’t hesitate to reach out with any questions or to discuss financial material.