The cost of living is increasing with each passing year. Even if you spend the same amount as you did in 2021, rising average selling prices (ASP) means you are walking away with fewer items for the same amount of money. For instance, filling up your car's gas tank, your grocery basket, or heating your home might be getting more costly. What's going on and how can you brace yourself as the costs, of seemingly everything, are going up?
You might want a fast answer as to how you can work around the inflation monster eating up your money. Let's first start with a better understanding of a few concepts.
What is Inflation? How are we impacted?
According to the rule of economics, inflation is an increase in the average level of prices for goods and services. A sample basket of goods and services is used to estimate price changes over time, since it’s not plausible to calculate the difference in price of every product and service separately.
Inflation can mean good things are happening in the financial system from a macro perspective. Higher prices of goods are often signs that consumer demand is high, that companies are growing and profitable, and that the economy is expanding. Currently, we are experiencing a mismatch between supply and demand, causing inflation to rise.
Many assume that inflation is a macroeconomic term and reflects the bigger economic picture of the country. This is correct, but it's also true that inflation affects us on a microeconomic level. The cost of things you purchase regularly is also impacted by inflation.
Following the pandemic, experts predict that Canada will face a period of increased inflation over the next several years. Those with low wages and fixed income will see their purchasing power reduced even further, leaving them with even less money for everyday essentials and unexpected expenses. If someone lives beyond their means, they need to take a breath and stop and look at where they're spending their money, recognize where they're overspending, and make changes in their spending habits to reduce their overall spending.
What is Canada’s inflation rate?
Annual inflation was 7.6% in July 2022, according to Statistics Canada. Meanwhile, average hourly wages rose 5.2% year-over-year. July’s inflation rate was down from June 2022’s rate of 8.1%, which was the highest rate Canadians had seen since 1983. July marks the 16th consecutive month that inflation has exceeded the Bank of Canada’s target rate of 2%.
According to a BNN report, 45% of Canadian firms "anticipate inflation will be above 3 per cent over the next two years."
Although current inflation in Canada is over 5%, here's how it's looked over the last few years:
| Year | Inflation Rate (%) |
|---|---|
| 2020 | 0.72% |
| 2019 | 1.95% |
| 2018 | 2.27% |
How does inflation affect my wallet?
Inflation has a substantial impact on your investments as well. This makes it more important to understand the mechanics of the concept so that you can make wise investments. If the percentage of returns on your investments is smaller than the inflation rate, then your money is losing value.
Similarly, changing interest rates directly impact any variable rate debts you have. A variable rate is the prime lending rate (the rate at which the Bank of Canada lends money to the financial institutions that work with consumers) plus interest charged by the financial institution. When the prime rate rises or falls, the interest rate you pay changes. Although there isn’t a change in your monthly payment amount, most of your payment will go towards paying off that high interest amount. That means less money going towards your loan principal leaving you in debt longer.
Fixed-rate debts are not affected by rising interest rates until you have to renew the terms, such as on a mortgage. Most credit cards and payday loans have fixed interest rates in Canada, but some low-interest cards come with variable rates. Home equity lines of credit (HELOC's) are usually variable, and student loans tend to have a variable component, as the prime rate is used in the federal component. When it comes to personal loans and mortgages, borrowers can often get a lower interest rate by taking a variable option, but they can quickly see it taking longer to pay down their principal amount if the prime rate goes up.
Another thing to note is when people buy a home, they often look less at the price of the property than what their monthly payment will be. Especially in today's world of sky-high real estate prices, homebuyers get past the sticker shock by focusing on the monthly payment. The prospect of an interest rate hike can be daunting for thousands of Canadian homebuyers who bought the property at record-high prices and record-low interest rates. New mortgage terms can make a big difference in your new monthly payment, and they can throw your budget into disarray if you weren't expecting it.
A substantial interest rate hike can quickly lead to mortgage arrears, where you cannot keep up with your payments, and you wind up owing back payments on your mortgage. It's a challenging position to be in, jeopardising your home's ownership.
Secured debt such as a mortgage can be harder to deal with than unsecured debts such as credit cards. With the help of a Licensed Insolvency Trustee, you can erase debts in Canada through a consumer proposal or bankruptcy, but debts with collateral cannot be included in insolvency proceedings unless you give up the asset.
How to hedge against inflation
"Someone's sitting in the shade today because someone planted a tree a long time ago" – these words of wisdom by Warren Buffet aptly summarise the essence of personal financial planning, especially the power of long-term investments. Robust financial planning today is your strongest shield from future uncertainties. As the world continues to grapple with market volatility, rapid inflation and uncertainty looming large after the pandemic, it's time to reconsider financial decisions.
High inflation can be a cause of financial stress for many Canadians. Increasing your income to align with prices is one way to hedge against inflation, but that's easier said than done for many reasons.
Here are other ways to manage soaring costs if making extra money isn't possible right now.
1. Revisit your budget
If inflation makes it difficult to stay within budget, take a moment to reassess your cash flow and where it's going. 66% of Canadians say their spending habits have changed in response to inflation, and many are adopting more conservative spending habits.
Start by determining if there are things you can temporarily do without to ensure essential needs are covered, like housing, groceries, transportation and utilities. For many, this reassessment may result in pressing pause on non-essential expenses like dining out, subscription services or gym memberships.
2. Take on new debt sparingly (and avoid variable rates)
Although the Bank of Canada kept debt interest rates low during the pandemic to offset inflation, it raised rates in 2022. When rates go up, variable-rate debts can suddenly cost more.
To hedge against this sudden increase, you might refinance your variable-rate mortgage into a fixed-rate loan or consolidate high-interest credit card debt into a personal loan with predictable payments. And be wary of taking on a lot of new debt in general: even when rates are low or fixed, new debt adds a new monthly payment to your budget and reduces your financial flexibility.
3. Become a bargain hunter/shopper
Speaking of essentials now is the time to get more serious about becoming a bargain hunter. This doesn't mean you need to spend your days clipping coupons, but rather that you might pay more attention to sales and allow them to guide where and when you shop. Forty-seven per cent of Canadians are paying more attention to sales and discounts in response to rising inflation, according to a recent survey. At the same time, 25% say they're switching to cheaper brands, and 20% are buying more items in bulk.
Taking advantage of price matching policies is another innovative way to save. It may mean being able to score an item you need at a steep discount or getting reimbursed if a recently purchased item goes on sale later.
4. Maximize loyalty and reward programs
Many Canadians participate in membership programs offered by their go-to grocery store, such as PC Optimum (the loyalty program operated by Loblaw Companies and Shoppers Drug Mart). Take a few minutes to look at your program's app or website before you go shopping and see the deals. Use them to inspire your shopping list and earn extra points for future spending.
And don't forget about credit card points or rewards you've accumulated. You may be able to redeem them for cash back, travel discounts and more. Furthermore, some credit card companies run occasional promos for cashing in points on things like merchandise or gift cards that could come in handy and help you save.
5. Prioritize fully funding your emergency fund
Consider a higher interest savings account or GIC to earn more on your short-term savings. The whole idea of an emergency fund is that you have access to money in short order. There are two parts to that: it has to be easily accessible, and it shouldn't be tied up in risky investments. For easy access, a savings account or redeemable GIC is ideal and simple. It's about as low as you can get on the risk scale, so it checks off both boxes. If you have an unused Tax-Free Savings Account contribution room, you can go one step better by setting up a high-interest savings account inside your TFSA.
Set a goal. Start with a smaller goal that you can achieve in three months. For example, setting an initial target of $500 would require an automated transfer of $40 per week. After 12 weeks, your account would be at $480. Tracking your progress can reinforce your efforts.
6. Stick to your plan
Finally, we caution you that predicting the future is difficult. Cutting out the wants in life for a month or two is an excellent way to kick-start any savings plan if you have the motivation. (Remember to avoid celebrating by rewarding yourself with an expensive treat!)
Haven't created a budget yet?
Now's a great time to start. Take an inventory of what you've been spending, and then do a line-by-line analysis to see where you can cut the fat. Any savings you find should be converted into additional automatic transfers to your emergency fund. Small changes today mean significant savings tomorrow. Try some of them and see if they make a difference. Inflation will come and go and will fluctuate many times throughout your lifetime. Having a well-planned strategy and financial plan will always help ease any concerns. Reacting to economic underperformance is the same as responding to economic surges. The key to success is to stay educated on these topics and by addressing any gaps in your plan now instead of later.