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Strategies to reduce the effects of inflation

(Photo: Eduardo Soares for Unsplash)

GUEST EXPERT. In a recent column, I discussed the importance of inflation in personal finances. In theory, a stable, relatively low and predictable level of inflation is quite appropriate and demonstrates a healthy level of economic activity. A drastic and sudden increase in inflation such as the one we have been experiencing for some time represents for many a shock to be absorbed at the financial level. Let’s look at some strategies that could help in a sudden high inflation environment.

Review your personal finances

To begin, note that this article does not take into account the measures that may have been contained in the recent budget of the Quebec government.

In the short term, a promotion or job change could improve working conditions and pay, which would help offset the effects of inflation. Of course, this is not always possible and promotions or job changes do not occur on a regular basis! A tip that is more accessible to everyone is to take a look at your financial situation to see if there are ways to improve it.

– Debts: it is better to prioritize the repayment of debts with the highest interest rates. Also, although savings account interest rates may rise with future Bank of Canada interest rate hikes, these rates are almost always lower than those on a loan or credit card. In this case, it is preferable to use these sums in a more effective way, that is to say to reduce the debt.

– The mortgage: because its interest rate is generally lower than that of other debts, it might be possible to use a small part of the equity to pay off a debt with a higher interest rate. Thus, the total amount of debt remains substantially equal, but the interest charge decreases.

– Taxes: the end of tax season is upon us; this is a good time to review your tax situation. Tax returns contain a multitude of information, it could be interesting to have them analyzed by a professional, who could detect gaps or strategies that you would not have thought of, and thus reduce your tax bill. Obviously, everything depends on your own situation, but you could check your eligibility and the possibility of using various tax credits and deductions based on age, personal and family situation or worker status, among others.

Investment strategies

Certain financial products and investment strategies can potentially benefit from an inflationary environment, while maintaining a long-term investment objective and an appropriate risk tolerance.

– Fixed income: it should be remembered that inflation generally leads central banks to increase their key rates, which negatively affects the value of bonds on the market. Holding bonds with shorter maturities can lessen this effect. Another possibility would be to diversify your bonds by opting, for example, for corporate bonds, global bonds or inflation-adjusted bonds.

– Equities: certain sectors of activity are less affected by a higher level of inflation. A strategy of rotating investments between various sectors may be appropriate. Also, financial securities providing income, such as dividends, could fare better in times of high inflation.

– Less traditional asset classes: one can invest in other asset classes, such as real estate, commodities and commodities. These asset classes can sometimes react more in sync with inflation, but with potentially higher volatility. Here again, it is important to establish your own investment strategy adapted to your risk tolerance.

retirement planning

From a longer-term perspective, inflation can affect retirement planning in two ways: higher costs of living and more limited retirement income. There are a few strategies and tips to keep in mind:

– When approaching retirement or at the start of it: it is a good idea to review your objectives and risk tolerance to ensure that the asset allocation is appropriate. It is important to plan the first years of retirement well by keeping part of your assets in cash or in more conservative investments from which to draw withdrawals. That being said, it is essential to maintain a long-term horizon for the entire portfolio, as retirement could last more than 25 years.

– In retirement: the vast majority of people will no longer have employment income and will therefore have to cover their cost of living from income from public programs, pension funds and their investments. Programs such as the Quebec Pension Plan (QPP) and the Old Age Security pension (PSV) allow benefits to be deferred over time by means of a substantial increase in payments. Postponing the application for the QPP and PSV pensions could therefore be a strategy to consider.

– The budget: it is important to determine the amount of fixed expenses that cannot be reduced, that is to say the part relating to housing, groceries, public utility services, etc. Then, one could opt to purchase a life annuity fully or partially indexed to inflation to cover these expenses in retirement. This pension, in addition to QPP and OAS benefits, would make it possible to cover the fixed part of the cost of living during retirement. The variable part of the cost of living could be covered by withdrawals from investments. This strategy provides greater peace of mind since annuity payments are guaranteed.

In summary, it is important to keep in mind the multiple consequences of sudden high inflation, while remembering that various strategies may be possible to protect against it, even if very often only partially.

Solomon Gamache, LL. M. Fisc., Pl. Fin., CLU, CIM, FCSI

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