With Higher Inflation, How to Alleviate Some of the Pain?

Ian Wood, CFP, CIM, MFA-A

This is Part 3 of a series of 3 articles.  In Part 1 we started by discussing the common measurements of inflation and introduced some of the major causes of inflation.  In Part 2, we discussed monetary and fiscal policies that are affecting inflation.  In Part 3, we will discuss strategies that we can use to help alleviate some of the pains from rising prices.

From a Portfolio Management Perspective

From a portfolio management perspective, owning investments that have historically performed well during previous periods of higher inflation would seem a good place to start.  Although all investment managers will tell you, “Past performance does not necessary indicate future returns,” we also know from Winston Churchill, “Those that fail to learn from history are doomed to repeat it.” 

Reviewing historical data from similar periods of high inflation during the 1970s and 80s, Peter Forsyth from the University of Waterloo suggests that, historically, a mix of an equal weighted equity portfolio and short-term bonds would have performed the best during high inflation periods[i]. 

This makes sense. Dividend-paying companies with strong balance sheets and a history of dividend increases offer the ability for the investor to benefit from steady and rising incomes that can outpace the rate of inflation over the long run.  Dividends reinvested during periods of market downturns will purchase quality companies, while their prices are trading at more attractive values for long-term investors. Short-term bonds have lower sensitivity to the aforementioned interest rate increases from the central banks and allow for earlier reinvestment of maturing bonds at the new higher interest rates at maturity.

From a Financial Planning Perspective

From a financial planning perspective, reviewing your financial plan to see if any changes need to be made to reach your goals given the current higher inflation and higher interest rates.  Mortgage amortizations need to be reviewed[ii], life insurance needs analyses need revisiting[iii], and budgets need to be reassessed to deal with rising costs for living expenses.

Those who have never budgeted in the past may do well with a conversation discussing the budgeting process.  A budget is a forward-looking tool to tell your money where to go, not figuring out where it went.  Higher inflation makes the process more difficult because costs in the future are more uncertain than in the past.  However, creating a budget with prioritized spending helps us understand the trade-offs we have to make between different goals.  Money can only be spent once, so allocating it efficiently towards expenses is important.

Through the budgeting process, it may become clear that money can be allocated towards four basic uses: Living, saving (or reducing debt), giving and taxes.  An increase in one of these areas will necessarily require a decrease in another. 

From a Tax-Planning Perspective

From a tax planning perspective, higher inflation provides us a reminder that we use after-tax money to pay for living expenses.  So, while we revisit our budget to look at ways to potentially save money by allocating our funds more efficiently, we should also be looking at various methods to reduce our tax burden by taking advantage of available options, such as: investing in tax-efficient accounts including RRSPs and TFSAs, reclaiming overpaid taxes in previous years due to filing errors, splitting pension income, spreading income over multiple tax years when possible and better managing access to funds within private corporations with intentional drawdown strategies[iv].  Reducing our income tax burden provides us with greater after-tax income to allocate toward rising living expenses, rather than requiring a reduction in saving and giving.

Bottom Line: While the current rate of inflation has recently decreased, costs continue to rise faster than we’ve seen in decades.  Proper planning from combining portfolio management, financial planning and tax planning perspectives can help alleviate some of the pain.

Key Takeaway: We can easily get wrapped up looking at what is causing prices to rise and forget to spend the time and energy to best protect ourselves against the pressures from the rising prices.  Back-to-basics strategies for portfolios, insurance, budgeting, and tax preparation offer us a valuable reminder that slow and steady wins the race.

[i] Forsyth, P. (2022). Asset Allocation During High Inflation Periods:. Waterloo: University of Waterloo.