Your investments’ worst enemy

It is important to consider the economic environment when investing your money. However, one economic factor with a huge influence on your returns is sometimes overlooked: inflation.

Maxime Bernier, current leader of the People’s Party of Canada is against inflation. During the seventh episode of Open Wallet, our show about personal finances, he talks about inflation’s impact on the lives of Canadians and their investments.

A disguised tax

The Bank of Canada sets the inflation rate. It usually amounts to plus or minus 2%. Bernier considers inflation as a disguised tax that is unhealthy for citizens, because “with the same amount of money, year over year, individuals cannot afford the same amount of goods and services.”

Inflation benefits people in debt. When they repay their debts, they do so with money that is less valuable than the money they originally borrowed. In other words, these individuals got a loan and obtained money with a certain purchasing power. Over the following years, they repay their debts with depreciated money.

Bernier therefore proposes setting inflation at 0%. This measure would enable Canadians to maintain their purchasing power year after year and better manage their personal finances. So if inflation is unhealthy for citizens, why is the government targeting 2% inflation with the Bank of Canada?

According to Bernier, the government is in debt and it borrows a lot of money in order to repay it. “The higher the inflation, the lower the government’s debt,” he said. In addition, as prices increase, so does government revenue.”

Savings and inflation

Of course, inflation has a negative impact on your savings. Let’s look at an example. First, let’s assume that you put $3000 into an account earning 3% interest each year, for 10 years. During this period, you will accumulate $34,457.59. On the other hand, if inflation during the same period was 2%, your savings are only $31,393.18 in terms of purchasing power. If there was no inflation during the period, your 3% interest would have increased your purchasing power by no less than $4457.59, compared to only $1393.18 in the 2% inflation scenario.

Does inflation drive investment?

Therefore, the higher the inflation, the more beneficial it seems to invest your money rather than allowing it to devalue in an account. But is the converse true? “When there’s no inflation, it’s fair, and it encourages savings and investment, depending on your investor profile”, said Bernier. Lastly, when there is no inflation, you have the choice to invest or not because your money does not lose its value over time. What is certain, however, is that a low inflation rate rewards savings and a high inflation rate rewards indebtedness.