The higher the inflation, the poorer we become.
Since everything costs more (transportation, gasoline, food, housing, leisure, etc.), the less money we have left in our pockets.
But in addition, we are hit hard by the negative impact of inflation on our investments.
Example. For each $100,000 capital tranche of savings, if annual inflation remains at 5%, this means that the “real” value of this heritage will only be worth $95,238 at the end of the year.
Thus, because of inflation, the “purchasing power” of this $100,000 will be reduced by $4,762, according to the Bank of Canada’s “Investment spreadsheet”, which electronic tool makes it possible to illustrate the financial consequences of inflation on investments and savings.
WHAT TO DO ?
To succeed in compensating for this loss of purchasing power, savers naturally rely on the investment income that their capital can generate.
However, due to inflation of at least 5% in 2022, the bar is high. Very high.
To compensate for inflation of 5%, it takes, before taxes, a minimum return of 7.7% on its investments.
THE EXPLANATIONS
Indeed, in the event that said capital of $100,000 is invested outside an RRSP, I have calculated that we would need to obtain a minimum return of 7.7% in interest income to successfully maintain our 100,000 $ of purchasing power.
Why such a “big” return? Because interest income from any non-RRSP investment is fully taxable, so there will be a tax bite.
However, on taxable income ranging from $50,197 to $92,580, the combined marginal federal and provincial tax rate in Quebec is 37.12%.
Thus, on an interest income of $7,700 per $100,000 capital tranche (7.7% of $100,000), you will have to pay $2,858 in taxes. Which will leave, net in our pockets, an income of $4842.
When we add this “interest income” of $4,842 to the value of our investment after inflation ($95,238), we find ourselves at the end of the year with a real capital of $100,080, i.e. the same real wealth or, if you prefer, the same purchasing power.
In other words, we will end the year without actually having a penny more in our pockets when we obtained a gross return of 7.7% on our investment.
UNATTAINABLE PERFORMANCE
Let’s come back to earth. It is currently impossible to obtain an interest yield of 7.7%. The best GICs (guaranteed investment certificates) currently yield around 3.85% for a one-year term, or half the return required (7.7%) to protect our purchasing power.
As for bonds with a maturity of approximately 1 year, we will obtain 2.8% with federal bonds, 3.0% with bonds issued by the Quebec government (including bonds distributed by Épargne Placements Québec), 3 .25% with municipal bonds and 3.7% with corporate bonds.
For the purposes of our example, an investment of $100,000 at 3.85% interest will earn $3,850 in interest income. After taxes, we are talking about a net amount of $2,421.
If we add this interest income of $2,421 to the real value of the investment after inflation ($95,238), we will end up with a real wealth of $97,659 at the end of the year.
So after 12 months our real wealth will be in the hole of $2341 compared to the initial value of our investment of $100,000
EVEN WORSE
The year 2022 promises to be all the more catastrophic for our personal finances as the value of our investment portfolios has suffered since the beginning of the year from the repercussions of the fall in the stock market and the significant drop in the bond market, there where government and corporate marketable bonds are traded.
So far, the Canadian stock market has lost nearly 10%, and the US stock market around 20%.
Things are not much better for Canadian government and corporate bonds, their market value having fallen by about 13% since the beginning of the year.
Being hit by both high inflation and a sharp drop in the financial markets greatly weakens everyone’s portfolios.
And this period of sharply rising interest rates could be disastrous for over-indebted households.
