Tag Archives: inflation

$1.7 million to retire: doable or out of reach?

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Front page of Wednesday’s Financial Post print edition.

Plenty of press this week over a BMO survey that found Canadians now believe they’ll need $1.7 million to retire, compared to just $1.4 million two years ago (C$). The main reason for the higher nest-egg target is of course inflation.

As you’d expect, the headline of the story alone attracted plenty of media attention. I heard about it on the car radio listening to 102.1 FM [The Edge]: there, a female broadcaster who was clearly of Millennial vintage deemed the $1.7 million ludicrously out of reach, personalizing it with her own candid confession that she herself hasn’t even begun to save for Retirement. Nor did she seem greatly fussed about it.

Here’s the Financial Post story which ran in Wednesday’s paper: a pick-up of a Canadian Press feed; a portion is shown to the left. The writer, Amanda Stephenson, quoted BMO Financial Group’s head of wealth distribution and advisory services Caroline Dabu to the effect the $1.7 million number says more about the country’s economic mood than about real-life retirement necessities.

BMO’s own client experience finds that “many overestimate the number that they need to retire,” she told CP, “It really does have to be taken at an individual level, because circumstances are very different … But $1.7 million, I would say, is high.”

Here’s my own take and back-of-the-envelope calculations. Keep in mind most of the figures below are just guesstimates: those who have financial advisors or access to retirement calculators can get more precise numbers and estimates by using those resources. I may update this blog with input from any advisors or retirement experts reading this who care to fill in the blanks by emailing me.

A million isn’t what is used to be

Image via Tenor.com

Back in the old days, a million dollars was considered a lot of money, even if that amount today likely won’t get you a starter home in Toronto or Vancouver. This was highlighted in one of those Austin Powers movies, in which Mike Myers (Dr. Evil) rubs his hands in glee but dates himself by threatening to destroy everything unless he’s given a “MILLL-ion dollars,” as if it were an inconceivably humungous amount.

The quick-and-dirty calculation of how much $1 million would generate in Retirement depends of course on your estimated rate of return. When interest rates were near zero, this resulted in a depressing conclusion: 1% of $1 million is $10,000 a year, or less than $1,000 a month pre-tax. When my generation started working in the late 70s, a typical entry-level job paid around $12,000 a year so you could figure that $1 million plus the usual government pensions would get you over the top in retirement.

Inflation has put paid to that outcome but consider two rays of hope, as I explained in a recent MoneySense Retired Money column. To fight inflation, Ottawa and most central banks around the world have hiked interest rates to more reasonable levels. Right now you can get a GIC paying somewhere between 4% and 5%. Conservatively, 4% of $1 million works out to $40,000 a year. 4% of $1.7 million is $68,000 a year. That certainly seems to be a liveable amount. More so if you have a paid-for home: as I say in my financial novel Findependence Day, “the foundation of Financial Independence is a paid-for home.”

Couples have it easier

If you’re one half of a couple, presumably two nest eggs of $850,000 would generate the same amount: for simplicity we’ll assume a 4% return, whether in the form of interest income or high-yielding dividend stocks paid out by Canadian banks, telecom companies or utilities. I’d guess most average Canadians would use their RRSPs to come up with this money.

This calculation doesn’t even take into consideration CPP and OAS, the two guaranteed (and inflation-indexed) government-provided pensions. CPP can be taken as early as age 60 and OAS at 65, although both pay much more the longer you wait, ideally until age 70. Again, couples have it easier, as two sets of CPP/OAS should add another $20,000 to $40,000 a year to the $68,000, depending how early or late one begins receiving benefits.

This also assumes no employer-pension, generally a good assumption given that private-sector Defined Benefit pensions are becoming rarer than hen’s teeth. I sometimes say to young people in jest that they should try and land a job in either the federal or provincial governments the moment they graduate from college, then hang on for 40 years. Most if not all governments (and many union members) offer lucrative DB pensions that are guaranteed for life with taxpayers as the ultimate backstop, and indexed to inflation. Figure one of these would be worth around $1 million, and certainly $1.7 million if you’re half of a couple who are in such circumstances.

Private-sector workers need to start RRSPs ASAP

But what if you’re bouncing from job to job in the private sector, which I presume will be the fate of our young broadcaster at the Edge? Then we’re back to what our flippant commentator alluded to: if she doesn’t start to take saving for Retirement seriously, then it’s unlikely she’ll ever come up with $1.7 million. In that case, her salvation may have to come either from inheritance, marrying money or winning a lottery.

For those who prefer to have more control over their financial future, recall the old saw that the journey of a thousand miles begins with a single step. In Canada, that step is to maximize your RRSP contributions every year, ideally from the moment you begin your first salaried job. Divide $1.7 million by 40 and you get $42,400 a year that needs to be contributed. OK, I admit I’m shocked by that myself but bear with me. The truth is that no one even is allowed to contribute that much money every year into an RRSP. Normally, the limit is 18% of earned income and the 2023 maximum RRSP contribution limit is $30,780 (and $31,560 for the 2024 taxation year.) Continue Reading…

Resource Stocks provide long-term gains and inflation hedging

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Photo from iStock

Including good stocks for long-term investment gains from the Resource section can be especially helpful in times of inflation. Learn more below.

For most investors, resource stocks should make up only a limited portion of their portfolios. That means that while we think you should maintain some exposure to resource stocks, you should still aim to balance your portfolio across most if not all of the five economic sectors.

If you want resource stocks in your diversified portfolio, then you need to know how to find good stocks in that sector for long-term investment gains.

Resource stocks, though volatile, tend to rise with inflation and can be good stocks for long-term investment gains

The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.

Back in the inflationary 1970s and 1980s, investors used to see this hedge-against-inflation ability as the main reason for buying resource stocks. But until recently, they rarely thought of it. That’s because inflation had waned for three decades.

Inflation peaked at a yearly rate around 13% in the early 1980s. It fell by two-thirds from that level by the middle of the decade. It went through a series of peaks and valleys, but had been working its way downward ever since.

However, after years of relative stability, inflation has come back to levels not seen in decades.

While the cost of just about everything has gone up, nobody can predict trends in inflation or interest rates with any consistency. And we disagree with investors who think we are on the verge of a huge outburst of never-ending price increases.

Even so, adding top Resource stocks to your portfolio lets prosper two ways: you can profit even without inflation — and these stocks will also provide an added boost in inflationary times.

It’s important to know your risk tolerance when investing in good stocks for long-term investment gains — including Resource stocks

There are several considerations that go into a successful growth investing strategy. Still, many investors overlook a number of important factors that can lower their risk.

In the end, there’s no such thing as risk-free investing. The tips below for lowering your growth investing strategy risk have long been part of the Successful Investor approach.

  • Balance your cyclical risk
  • Be skeptical of companies that mainly grow through acquisitions
  • Don’t overindulge in aggressive investments
  • Keep an eye out on a growth stock’s debt
  • Keep stock market trends in perspective
  • Look for growth stocks that have ownership of strong brand names and an impeccable reputation
  • The best long-term growth stocks should have the ability to profit from secular trends

Meantime, we continue to recommend that you cut your risk in the volatile resource sector by investing mainly in stocks of profitable, well-established mining companies with high-quality reserves. And as mentioned, resource stocks (and this includes oil and gas, of course) should make up only a limited portion of your portfolio. Continue Reading…

Retired Money: Inflation and some compensations in federal tax brackets and contribution limits

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My latest MoneySense Retired Money column has just been published and can be accessed by clicking the highlighted headline: Inflation and investments: Heads up if you’re retired or retiring soon. 

It looks at the anxiety of would-be retirement savers in the light of soaring inflation and in particular, a recent Leger Questrade poll that looked at how inflation is affecting Canadians’ intentions to contribute to TFSAs and RRSPs. My Hub blog on this includes 4 charts on the topic.

Not surprisingly, inflation is a particular concern for retirees and those hoping to retire soon. The 2023 RRSP Omni report found that while 87% of Canadians are worried about rising prices, it also found 73% of RRSP owners still plan to contribute again this year, and so do 79% of TFSA holders. That’s despite the fact 69% fret that inflation will impact their RRSPs’ value and 64% worry about their TFSAs’ value. Seven in ten with RRSPs and 64% with TFSAs are concerned about inflation and a possible recession: 25% “very” concerned.

A Silver Lining

The MoneySense column also summarizes some of the compensating factors that Ottawa builds into the retirement saving system: as inflation rises, so too do Tax brackets, the Basic Personal Amount (BPA: the tax-free zone for the first $15,000 or so of annual earnings), and of course TFSA contribution limits (now $6500 in 2023 because of inflation adjustments). This was nicely summarized late in 2022 by Jamie Golombek in the FP, and reprised in this Hub blog early in the new year.

Because tax brackets and contribution levels are linked to inflation, savers benefit from a little more tax-sheltered (or tax deferred) contribution room this year. The RRSP dollar limit for 2023 is $30,790, up from $29,210 in 2022, for those who earn enough to qualify for the maximum. And TFSA room is now $6,500 this year, up from $6,000, because of an inflation adjustment. As Golombek noted, the cumulative TFSA limit is now $88,000 for someone who has never contributed to one.

Golombek, managing director, Tax & Estate planning for CIBC Private Wealth, wrote that in November 2022, the Canada Revenue Agency said the inflation rate for indexing 2023 tax brackets and amounts would be 6.3%: “The new federal brackets are: zero to $53,359 (15%); more than $53,359 to $106,717 (20.5%); more than $106,717 to $165,430 (26%); more than $165,430 to $235,675 (29%); and anything above that is taxed at 33%.”

Another break is that the yearly “tax-free zone” for all who earn income is rising. The Basic Personal Amount (BPA) —the annual amount of income that can be earned free of any federal tax — rises to $15,000 in 2023, as legislated in 2019.

CPP and OAS inflation boosts in late January

 On top of that, retirees collecting CPP and/or OAS can expect significant increases when the first payments go out on or around Jan. 27, 2023. (I include our own family in this). There’s more information here. Continue Reading…

All good things must come to an end: There by the grace of Paul Volcker went Asset Prices

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Image courtesy Creative Commons/Outcome

By Noah Solomon

Special to Financial Independence Hub

During the OPEC oil embargo of the early 1970s, the price of oil jumped from roughly $24 to almost $65 in less than a year, causing a spike in the cost of many goods and services and igniting runaway inflation.

At that time, the workforce was much more unionized, with many labour agreements containing cost of living wage adjustments which were triggered by rising inflation.

The resulting increases in workers’ wages spurred further inflation, which in turn caused additional wage increases and ultimately led to a wage-price spiral.The consumer price index, which stood at 3.2% in 1972, rose to 11.0% by 1974. It then receded to a range of 6%-9% for four years before rebounding to 13.5% in 1980.

Image New York Times/Outcome

After being appointed Fed Chairman in 1979, Paul Volcker embarked on a vicious campaign to break the back of inflation, raising rates as high as 20%. His steely resolve brought inflation down to 3.2% by the end of 1983, setting the stage for an extended period of low inflation and falling interest rates. The decline in rates was turbocharged during the global financial crisis and the Covid pandemic, which prompted the Fed to adopt extremely stimulative policies and usher in over a decade of ultra-low rates.

Importantly, Volcker’s take no prisoners approach was largely responsible for the low inflation, declining rate, and generally favourable investment environment that prevailed over the next four decades.

How declining Interest Rates affect Asset Prices: Let me count the ways

The long-term effects of low inflation and declining rates on asset prices cannot be understated. According to [Warren] Buffett:

“Interest rates power everything in the economic universe. They are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that’s a huge gravitational pull on values.”

On the earnings front, low rates make it easier for consumers to borrow money for purchases, thereby increasing companies’ sales volumes and revenues. They also enhance companies’ profitability by lowering their cost of capital and making it easier for them to invest in facilities, equipment, and inventory. Lastly, higher profits and asset prices create a virtuous cycle – they cause a wealth effect where people feel richer and more willing to spend, thereby further spurring company profits and even higher asset prices.

Declining rates also exert a huge influence on valuations. The fair value of a company can be determined by calculating the present value of its future cash flows. As such, lower rates result in higher multiples, from elevated P/E ratios on stocks to higher multiples on operating income from real estate assets, etc.

The effects of the one-two punch of higher earnings and higher valuations unleashed by decades of falling rates cannot be overestimated. Stocks had an incredible four decade run, with the S&P 500 Index rising from a low of 102 in August 1982 to 4,796 by the beginning of 2022, producing a compound annual return of 10.3%. For private equity and other levered strategies, the macroeconomic backdrop has been particularly hospitable, resulting in windfall profits.

It is with good reason and ample evidence that investing legend Marty Zweig concluded:

“In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major direction.”

To be sure, there are other factors that provided tailwinds for markets over the last 40 years. Advances in technology and productivity gains bolstered profit margins. Limited military conflict undoubtedly played its part. Increased globalization and China’s massive contributions to global productive capacity also contributed to a favourable investment climate. These influences notwithstanding, 40 years of declining interest rates and cheap money have likely been the single greatest driver of rising asset prices.

All Good things must come to an End

The low inflation which enabled central banks to maintain historically low rates and keep the liquidity taps flowing has reversed course. In early 2021, inflation exploded through the upper band of the Fed’s desired range, prompting it to begin raising rates and embark on one of the quickest rate-hiking cycles in history. Continue Reading…

Despite inflation, Canadians still prioritizing retirement and contributing to RRSPs and TFSAs

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While the vast majority (87%) of Canadians are worried about rising costs from Inflation, Questrade Leger’s 2023 RRSP Omni report finds that 73% of RRSP owners plan to contribute again this year, and 79% of TFSA holders plan to recontribute. That’s despite the fact 69% fret that inflation will impact their RRSP’s value and 64% worry about the impact on their TFSA’s value.

“The number of Canadians who are saving for retirement remains consistent with previous years,” the report says. “Among those who are saving for retirement, about three-in-five (58%) say they are very worried compared to Canadians who are not saving for retirement. Women are also more likely to be very worried about the costs associated with rising inflation.”

Seven in ten respondents who have RRSPs told the panel they are concerned about the rising costs associated with inflation and a possible recession: 25% indicate that they are very concerned. “A similar trend is observed among those who hold TFSAs for retirement purposes, with almost two-thirds (64%) indicating that they are concerned.”

 

Worries about inflation and recession “raise questions about the ability of Canadians to control their financial future, especially when it comes to retirement,” the report says. These concerns are most acute for those with an annual income of less than $100,000: “These Canadians are also more likely to agree that they will have to draw upon their savings or investments to cover their expenses in the coming year.”

Less than half are confident about their financial future

Less than half feel they are confident when it comes to their financial future: “Only those making over $60K have confidence in their own financial future despite the current state of the economy.”

The survey seems to imply that Canadians value TFSAs a bit more than RRSPs, based on willingness to max out contribution room of each vehicle. Of course, annual TFSA room only this year moved up to $6500 per person per year, less than a quarter of the maximum RRSP room of $30,780 in 2023, for those with maximum earned income.

Only 29% of RRSP holders plan to maximize their RRSP contribution room in 2023, compared to almost half (46%) who plan to max out their TFSAs. The most enthusiastic TFSA contributors are males and those aged 55 or older.

Given economy, most worry about rising cost of food and everyday items  

Day-to-day living expenses continue to be a concern in the face of rising inflation: 79% worry about rising food prices and 77% rising everyday items. The third major concern (for 45%) is inflation’s impact on savings/investments and fourth (at 30%) is rising mortgage costs. Depending on annual incomes, worry over inflation can centre either on investments or on debt:  those in the middle to upper income brackets ($60K or more) “are much more likely to find the impact on savings / investments and increasing mortgage concerns more worrisome than compared to those who make less than $60K.”

Ability to save impacted by inflation

Three in four (74%) agree that inflation has impacted their ability to save, at least somewhat. And half (47%) have had to draw upon their savings or investments to cover expenses due to rising costs, especially those under 55 and those who are not currently saving for retirement. Many Canadians also agree they will have to draw upon their savings/investments to cover expenses in the coming year (43%). Continue Reading…