What is the real value of your portfolio?
How to keep up with the fluctuations of inflation and volatility of the dollar
When it comes to reading the market, factors such as inflation and shifting currency values can flummox even the savviest investors. Yet despite market instability, there are ways to help prevent your money from losing its value. Understanding inflation Inflation is simply the price of goods and services increasing over time. If the rate of inflation is higher than your after-tax investment earnings, you’ll actually be worth less over time, because you’ll be able to buy less with your money. “Historically, cash accounts, GICs and most government bonds grow slower than the rate of inflation on an after-tax basis,” says Jason Pereira, a senior financial consultant at Woodgate Financial Inc. & Investment Planning Counsel.
“These fixed-interest investments are very low risk, but typically don’t grow quickly enough to keep pace with inflation after you factor in taxes.”
Portfolio managers generally agree that dividend-paying stocks will do better against inflation. “If you don’t have some degree of equity exposure in your portfolio, you’re probably not maintaining an after-tax rate of return greater than inflation,” adds Pereira. In times of rising inflation, real return bonds (government-issued bonds that pay a percentage based on the Consumer Price Index), commodities such as precious metals and real estate tend to hold their value.
Guy Anderson, senior financial consultant at Parkview Financial and Investment Planning Counsel, recommends looking at annuities that are indexed against inflation. “You should also find ways to minimize or defer paying taxes. Deferring taxes using structures like registered retirement savings plans (RRSPs) are great ways to use inflation to your advantage.”
Currency fluctuations These have been a huge issue in the last few years. Compared to the U.S. dollar, the loonie has been extremely volatile over the past decade and a half, with our dollar swinging from about 62 cents, up to $1.10 and back down. How does that affect investors?
“Currency swings influence what you can buy with your money and the value of your portfolio, especially if you have a lot of U.S. investments,” says Pereira. “To protect investors, portfolio managers can buy derivatives to insure against fluctuations to offset the money investors lose, a process called hedging.”
Pereira recommends investing in mutual funds or exchange-traded funds with hedges on them, so you’re protected against currency swings. It potentially eliminates the currency risk — “it will give you a more stable portfolio” — though you will miss out when the currency swings in your direction. The volatility of the dollar will also affect those who own real estate south of the border. “If you’re planning on spending winters in Florida, for example, you may want to draw some of your income from a portfolio in U.S. dollars and create a cash reserve in U.S. funds, so you aren’t as affected by the fluctuations,” says Anderson.