Inflation refers to an increase in the prices of goods and services in a country. This would result in the lowered purchasing power of the currency. The same unit of currency will now buy lesser goods and services compared to a recent period. The rate of inflation is how much prices increased or decreased during a period.
Inflation over time in Canada
I am referring to the Inflation Calculator on this Bank of Canada webpage to present the following visuals. We’re looking at a basket of goods and services consisting of food, shelter, clothing, transportation, and recreation.
The same basket of goods and services that costed $100 in 1950 would cost 11 times more in 2020.
Given that inflation is one of the most pressing issues in 2022, I would like to show you how this basket of goods and services has become significantly more expensive since 2008. Transportation (fuel) costs have led the way when it comes to individual categories. The impact of fuel costs is also felt across other categories where shipping contributes to the final price of a product or service.
The $100 basket from 2008 now cost $132 in 2022. The strongest change is observed between 2021 and 2022. The difference between the two years is about 6.77%.
Why is this worrisome for households?
Simply because things are getting a lot more expensive than they previously were. The visual below represent the change in Consumer Price Index from April 2022 to April 2021.
All categories of CPI saw an increase. The categories that saw the highest Year over year increase are Transportation at 11.2%, food at 8.8% and shelter at 7.4%. All in all, the overall Consumer Price Index registered an increase of almost 7%.
This increase in the cost of goods and services between the two recent years denotes that the purchasing power of households has declined significantly over the two years. Supply chain issues during the pandemic, increased cash balances after an isolated 2021, stimulus checks from the government and other global factors (such as the Russian invasion of Ukraine) etc. have all had an impact.
What are different inflation types ?
Demand Pull Inflation – Prices inflate due to increased consumer demand. An example could be microchip price rise in 2021 owing to increased customer demand for microchips. Note that production issues for semiconductors during pandemic also contributed to this price increase.
Cost Push Inflation – This is inflation owing to increased cost in production of goods and services. War as an example can disrupted crude oil supply resulting in increased cost of production across multiple industries. The increased cost is then passed to the consumer.
And finally, what can I do to protect myself and my investments ?
Not hoarding cash is super critical in this time. Most Savings accounts have interest rates lower than the rate of inflation meaning that the purchasing power of your money will erode at this time. It is at the same time important to have or maintain your emergency funds.
Short term bonds are considered a better option than holding cash given a confirmed interest payment. Long term bonds may not be as good an investment if the interest rates go up. Interest can go up over time during inflation to slow the economy.
The stock market has historically provided returns upwards of 7%-8% per annum and if you have a longer-term horizon, staying invested could be well worth the wait. Dollar cost averaging into the stock market could be something worth considering. Stock picks should be done after detailed research and you should consider stocks with a MOAT and a decent track record.
Diversification across sectors, markets and currencies could be a good strategy irrespective of the inflation status. Mutual Funds and ETFs can help achieve this diversification. Real Estate has also been considered a viable option to diversify in the past. But given the exponential increase in real estate markets recently, analysts have expressed some reservations in real estate as a tool against inflation.
And as always, experts recommend not investing or divesting based on emotions.