Managing Inflation: Guide to Protecting Your Finances
(Six-minute read time)
Inflation can significantly impact your purchasing power and overall financial health. In this article, we will explore the fundamentals of inflation, its effects on your daily life, and practical tips for handling inflation. Additionally, we have included a comprehensive FAQ about inflation and a free PDF download to help you stay on track with your financial goals.
What is Inflation?
Inflation refers to the increase in prices of goods and services over time, which reduces the purchasing power of money. It means that, on average, things cost more now than they did in the past. The Consumer Price Index (CPI) measures this change in price levels and is updated monthly by the Bank of Canada. When the CPI goes up, it indicates that inflation is occurring, which can impact everything from groceries and gas to mortgages and savings.
Effects of Inflation
Understanding the impact of inflation on interest rates and borrowing costs can help you make informed financial decisions. When the Bank of Canada raises the key interest rate (also known as the policy interest rate and overnight interest rate), it impacts other interest rates, such as the prime rate and mortgage rates set by financial institutions. As a result, borrowing money becomes more expensive. This means higher costs for mortgages, loans, and credit. Conversely, when interest rates are lowered, borrowing becomes cheaper, encouraging spending and investment.
Why Does the Bank of Canada Raise Interest Rates?
Raising interest rates helps control inflation. By raising the key interest interest rate, the Bank of Canada aims to reduce spending and borrowing. When people and businesses spend less, the demand for goods and services decreases, which can help lower inflation.
Imagine the prices of groceries and gas are rising quickly. To slow down this increase, the Bank of Canada might raise the key interest rate, making it more expensive to borrow money. This reduces overall spending, helping to control price rises.
Why Does the Bank of Canada Lower Interest Rates?
Lowering interest rates boosts the economy. Lowering interest rates makes borrowing cheaper, encouraging spending and investment. This can help stimulate economic growth, especially during periods of low inflation or recession.
If the economy is slow and prices are stable or falling, the Bank of Canada might lower the key interest rate. This makes borrowing cheaper, encouraging people and businesses to spend and invest more, boosting the economy.
Click the Video to Find Out How the Bank of Canada Affects Your Mortgage Rate
To learn more about when variable and fixed-rate mortgages go up, visit our article: When Do Mortgage Rates Go Up?
Inflation & Interest Rates in Canada Throughout the Decades
The inflation rate in Canada has been maintained between 1-3% by the Bank of Canada, with an average inflation rate of 2.81% in 2024. To control inflation, the Bank of Canada adjusts the key interest rate, which in turn impacts other interest rates, such as the prime rate and mortgage rates set by financial institutions.
From the chart below, you can see that during the 2008 Financial Crisis and the COVID-19 pandemic, prime rates were kept low to stimulate the economy. Historically, today’s rates aren’t high compared to the early 1980s when rates soared. However, what's notable now (June 2024) is that the prime rate (7.2%) is higher than the 5-year conventional mortgage rate (6.84%). Typically, the prime rate is lower due to less risk perceived by the financial institutions. The current scenario suggests the market expects economic conditions to worsen.
Understanding these dynamics helps homeowners make informed decisions about mortgages and financial planning. By monitoring rates, you can better anticipate changes in mortgage payments and overall financial health.
How to Manage Rising Inflation
Although current inflation is relatively lower compared to previous years, there is always potential for it to rise. Here are some tips to handle rising inflation:
Dollar-Cost Averaging: Consider breaking down your investment purchase into smaller chunks to reduce risk. This strategy involves investing a fixed amount of money at regular intervals, regardless of the market price, resulting in an average cost per unit purchased, saving you time and the stress of trying to time the market perfectly. This strategy is especially beneficial for younger investors with a longer timeline. To learn more, read our article: When Should I Start Investing?
Invest in a Diversified Portfolio: Invest in a diversified portfolio to combat the effects of inflation. With an average inflation rate of 2.81%, your investments should aim to earn at least 2.81% in returns. Since savings accounts and GICs often don't offer enough interest, it's important to have a mix of stocks, bonds, and other assets to protect against inflation.
Adjust Your Budget: Review and adjust your budget to account for higher prices. Prioritize essential expenses and look for ways to cut back on non-essential spending.
Seek Higher Returns: Explore investments that historically outpace inflation, such as real estate or certain types of stocks. While these come with risks, they also offer the potential for higher returns.
Review Savings Accounts: Traditional savings accounts may not keep up with inflation. Consider high-interest savings accounts or other financial products that offer better returns.
Monitor Interest Rates: Keep an eye on interest rates set by the Bank of Canada. When inflation is high, interest rates often rise, affecting loans and mortgages. Adjust your financial strategies accordingly.
Talk to Your Financial Advisor: Consult your financial advisor for personalized advice. Be skeptical of social media influencers and look at many sources for information. Why You Shouldn’t Trust Social Media Influencers
Most Investments Come With Risks
Take our risk profile quiz and find out what your own risk tolerance is.
Tips to Combat Rising Grocery Costs
As inflation rises, so do food prices in Canada. According to Canada’s Food Price Report 2024, overall food prices are projected to increase by 2.5% to 4.5%. In 2024, a family of four is anticipated to spend an annual amount of about $16,000 on groceries.
To save money, plan ahead and find the best deals. Here are some tips to help you manage your grocery budget:
Make a List: Avoid impulse buys by sticking to a shopping list.
Meal Plan: Plan your weekly meals to focus only on the necessary ingredients.
Compare Prices: Shop where the sales are and consider price matching.
Use Coupons: Coupons can save money, especially on cleaning supplies, personal care items, and baby products.
Earn Points: Shop at stores with rewards systems to accumulate points that can be redeemed for discounts.
Buy in Season: Purchase locally grown fruits and vegetables in season for significant savings. Consider also preserving these seasonal foods to enjoy during the winter.
Buy in Bulk: Purchasing in bulk can be cheaper, especially for large families. Consider shopping wholesale or liquidation stores for more savings.
Choose Generic Brands: Choose generic brands instead of name brands for basics like beans, pasta, and ice cream to save money.
These simple strategies can help you manage your grocery budget and combat rising prices effectively.
Money Saving Tips for Managing Inflation
Here are some practical saving tips to help you manage your finances more effectively and reach your financial goals:
Know Your Needs: Only pay for what you need. For example, don't buy an expensive phone if you won't use all its features. Avoid unnecessary expenses. To learn more and download our free budget template, visit our article: How to Make a Budget.
Do Your Research: Check reviews and compare prices online before buying. Contact sellers to ask about upcoming sales and return policies.
Negotiate: Don't be afraid to negotiate prices. Businesses often offer discounts or extra services. If they can't meet your needs, be prepared to walk away.
Monitor Your Bills: Check your bills for errors and address any issues immediately.
Review Insurance and Investments: Ensure your insurance policies and investments reflect your current needs. Keep an eye on fees and adjust as necessary.
Work with Your Financial Advisor: Your advisor can help you save money and invest wisely to meet your long-term goals. To learn more, read our article: How to Choose a Financial Advisor
Maximize Your Savings: Invest your savings to grow them. Consider dollar-cost averaging or using extra savings to pay down high-interest debt.
Achieve Your Financial Goals
Dealing with inflation requires a proactive approach to managing your finances. By understanding what inflation is and how it affects your expenses, you can take steps to mitigate its impact. Implementing strategies to handle inflation, such as smart shopping tips and effective saving techniques, can help you maintain financial stability. Don't forget to review our FAQ section for more insights and download our free PDF to set and achieve your financial goals.
For more information about how you can explore new opportunities and ensure your finances can withstand inflation, book a call with us today.
FAQ on Inflation for Ontario Residents
-
Inflation refers to the rise in prices of goods and services over time, reducing the purchasing power of money. It is measured by the Consumer Price Index (CPI), which is updated monthly by the Bank of Canada.
-
Inflation affects the cost of living by increasing prices for everyday items like groceries, gas, and housing. It can also impact savings and investments, as the value of money decreases over time.
-
When inflation is high, the Bank of Canada often raises the key interest rate to cool down the economy.
Higher interest rates make borrowing more expensive, which can reduce spending and slow inflation.
-
High inflation leads to higher interest rates, which increase the cost of borrowing for mortgages, loans, and credit cards. This can make it more expensive to finance big purchases or carry debt.
-
Dollar-Cost Averaging: Invest regularly to take advantage of market fluctuations.
Diversified Portfolio: Spread your investments across various asset classes to balance risk.
Adjust Your Budget: Prioritize essential expenses and reduce non-essential spending.
Seek Higher Returns: Explore investments that historically outpace inflation, like real estate or stocks.
-
Plan Your Meals: Create a weekly meal plan to avoid impulse purchases.
Make a Shopping List: Stick to a list to stay focused and on budget.
Compare Prices: Shop where the best deals are and consider price matching.
Use Coupons and Points: Look for coupons and support stores with rewards systems.
Buy Seasonal and Bulk: Purchase seasonal produce and bulk items for better savings.
-
Avoid Unnecessary Upgrades: Only pay for features you need, like in phone plans.
Research Before Buying: Compare prices and read reviews to find the best deals.
Negotiate: Ask for discounts or additional services when making significant purchases.
Check Bills and Statements: Ensure accuracy and address any errors promptly.
Review Insurance and Investments: Make sure they reflect your current needs and circumstances.
-
Invest Wisely: Use a diversified investment strategy to grow your savings.
High-Interest Accounts: Consider high-interest savings accounts or GICs.
Stay Informed: Regularly review your financial plans with a trusted advisor.
-
Traditional savings accounts often don't keep up with inflation, meaning the real value of your money decreases over time. High-interest savings accounts or other investment products can offer better returns and help maintain your purchasing power.
Recognized By
Interested in Learning More About Investing?
Check out our additional resources:
