Unless you have been living under a rock in 2022, you will have first-hand experience dealing with the level of inflation that is plaguing many developed nations. Canada’s inflation rate, currently 6.8% based on April’s metrics, is the highest level since January 1991.

Inflation, in a nutshell, is defined by the lost value of currency over time. Using Canada’s current inflation rate as an example, it means that if you had $1.00 in April 2021 then you actually would need between $1.06 – $1.07 in April 2022 to purchase the same amount of items that your loonie was able to purchase in April 2021. It can seem negligible when you are talking about loonies and cents but it becomes substantial when you start talking about larger dollar figures or its effect over longer periods of time.

For informative purposes, Canadian inflation has averaged:

2.24% over the last 5 years

1.8% over the last 10 years

1.93% over the last 20 years

3.52% since 1950

So, let’s look at an example based on the different annual inflation rate averages from above. You can see that the greater the rate of inflation then the greater loss of purchasing power over time. If inflation was to stay as low as 1.8% then, after 30 years, you would be able to purchase about $0.58 worth of goods. If inflation was to stay as high as 3.52% then, after 30 years, you would be able to purchase about $0.34 worth of goods.

I spoke about inflation and the corresponding risks to the majority of Canadians who will be required to create a retirement income for themselves previously. The article was written in October 2021 and was titled, “The Invisible Thief,” and you can find it here.

When you look at inflation and its effects on debt then the relationship gets interesting. Before I jump into any analysis, I want to discuss the differences between “Good” Debt and “Bad” Debt. Investopedia summarizes these terms by suggesting that Good Debt has the potential to increase your net worth or enhance your life in an important way and Bad Debt involves borrowing money to purchase rapidly depreciating assets (eg. a new car) or only for the purpose of consumption (eg. travel). Good Debt usually has low and attractive interest rates and Bad Debt usually has higher interest rates and should be paid off as soon as possible, but this relationship doesn’t always exist. Everyone’s emotional response to debt is different so I am not advising anyone to act on any information within this article other than for informative purposes to make their own decision with the help of a professional.

While we are working in our careers, most workplaces will increase the income of staff every year by some percentage (usually around 2% – 3% by default to account for inflation). If your income does not increase then, effectively, your employer is awarding you with an annual reduction in income.

Imagine you take out a loan that lasts 30 years, and every month, you owe $100. Regardless of what happens with your income and inflation, you still owe $100 per month over the course of the loan. As time goes on, the payment of $100 means less and less to you because the value of a dollar diminishes over time. It doesn’t matter to your lender that your income increases over time, the only thing that matters is that the lender continues to receive their minimum payments and you do not break the terms of the loan.

This does not mean that you should only pay the minimum payment amount on debt and spend the rest frivolously. It means that it may make more sense to take any extra funds that you were allocating to debt, over and above the minimum payment, and re-allocate these funds into an investment solution. Not any investment solution will work though, remember, if you aren’t earning more than the average rate of inflation over time then you are effectively losing money.

Want to chat about it? Email me at info@financerx.ca.