Price Inflation in Canada: How Can I Protect My Savings From Inflation Risk?

by Chris W. Rea on

This is the fourth post in the Price Inflation in Canada series from my inflation calculator app. The other posts introduced inflation, motivated Canadians to care about inflation, and described how StatsCan measures price inflation using the CPI.

What’s the risk in “guaranteed” savings?  Inflation Risk.

There are many reasons to save: for a rainy day, in advance of a major purchase, for a child’s education, for retirement. But some savers make a mistake and keep all of their long-term savings in the bank or in “savings” bonds marketed by the government. Such “guaranteed” products tend to perform poorly relative to inflation.

The typical Canadian bank account and federal government “savings” bonds pay interest rates considerably lower than inflation. The price you pay to keep money in these products over the long term is the significant erosion of your money’s purchasing power.

Example: Ben, 35, is saving money for retirement — a long-term goal. Ben didn’t want his money at “risk” and didn’t consider other investment options. Ben keeps his retirement savings in his Big Five bank’s “premium rate” retirement savings account, earning just 0.50% interest per year, while price inflation averages 2.25% per year. If Ben’s $50,000 stays put for 25 years, assuming the same rates and ignoring additional deposits, then Ben is in for a nasty surprise: his hard-earned $50,000 “grew” to $56,640 in nominal terms, but his savings have lost 35% of their real purchasing power.

Products paying paltry interest pose a serious inflation risk to the purchasing power of money. While bank accounts and savings bonds guarantee your money in nominal terms, there are options that may better maintain money’s purchasing power.

Consider becoming an investor.

For long-term goals like retirement, better than just saving money is to be an investor. Investors save money, then seek to improve their purchasing power by allocating their capital wisely. Learn about investing’s rewards and risks.

Small investors with long-term goals typically build diversified portfolios with stocks, investment-grade bonds, and other assets using mutual funds or exchange-traded funds (ETFs). While investing carries additional risks, a well-built portfolio can beat inflation.

Smart investors think about investment returns relative to inflation. To increase purchasing power, your portfolio’s returns — after all fees — must exceed inflation. Low-fee stock index and short-term government bond index funds may form the core of a portfolio. Other specific kinds of assets like real-return bonds and commodity funds have a good chance to keep up with inflation and can be part of a well-diversified portfolio. However, be mindful of fees and work to minimize your up-front, ongoing, and exit costs. If you aren’t careful, it’s easy to give up a good chunk of your return in fees.

If you’re not comfortable managing your own investments, then be sure to choose financial advice carefully. Prefer certified financial planning professionals who charge a set fee for their service. Be cautious with advisors who work on commission to push investment products. Commission-based advice is seldom unbiased, and often associated with higher fees and poorly performing products. Seek to understand any investment product before you put money into it.

The last post in this series will list resources to help you learn more about inflation, investing, and personal finance.

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