Inflation: Everything is upside down, or is it back to 'old normal'?
Pretty much everything in the financial world is upside down right now. The advice I have been giving for the last 13 years of my career has turned on its head. That means you should look at what you are doing with your money and decide if you should still be doing it.
Things have changed because interest rates have gone up
For all of my career until now, I've had to explain inflation to clients. Few people really understood it since it hasn't been a problem for more than 40 years. When prices rise by a percent or two a year, it's hard to notice. And if that's the inflation rate you've seen your entire life, I wouldn't blame anyone for not paying attention to it.
It's like when your wife goes to the hairdresser for the first time since the start of the pandemic and gets an inch trimmed off, and you don't notice. But then her mom comes over and compliments her haircut. Suddenly, what didn't matter now matters a whole lot. HOW WAS I SUPPOSED TO KNOW? IT WAS AN INCH! I'M SORRY!
Anyway.
Everyone now understands inflation after seeing the prices of everything from gas to food to housing rise rapidly in the past year. Rapidly rising prices is a bad thing. For an example of what can happen if we don't tame this, think about Germany in the 1920s. It got to a point where a wheelbarrow of money couldn't buy a newspaper. What happened in the following three decades is not something anyone wants to repeat.
Right now, Argentina, Venezuela and Turkey are facing uncontrollable inflation. As the value of their currencies tanks, they can't afford to import much since no one wants to touch their currency. What would happen to our national food supply if we in the Great White North couldn't afford imports anymore? We could say goodbye to fresh fruits and vegetables for eight months of the year, that's for sure!
Like a kid way past his bedtime and hopped up on sugar, running around a fancy restaurant, we need to get inflation back under control before something bad happens.
Luckily, we aren't the only country facing this problem. Pretty much every government in the world printed too much money to save people and businesses from bankruptcy due to the lockdowns. In hindsight, we now see that pretty much every government in the world overshot, and now there's too much money lying around chasing limited goods, which causes prices to go up or money to be worth less. Hence, inflation.
How do you cure inflation? The quickest way (since few politicians are involved) is to reduce how much extra money businesses and people have lying around through higher interest rates. This economic engineering is effective because it causes a ripple effect.
If you or your business has to pay more interest, there's less money to spend on other stuff. You might even consider paying off debt faster as interest costs rise, which means less money for stuff.
This brings me back to how much of my advice to clients now is upside down from the past 13 years.
Should you invest or pay off debt?
The math used to be easy. If you had a mortgage or a line of credit with an interest rate under 3%, it was better to pay that off slowly so you had more cash to invest. Investments rise at 6-8% annually on average, depending on your risk tolerance. So, in the end, you would be wealthier having carried the debt longer and investing more. Of course, many people feel uncomfortable doing that, which is why personal finance is, well, personal.
For the first time in 13 years, I have been telling some clients to prioritize paying off their credit lines and even mortgages instead of investing. And I'm in the investment management business!
When the interest on your debt is 6% or more after tax, it's hard to find an investment that will reliably beat that in the long run by enough to make the stress of it all worth it. Please don't misconstrue this as advice for your specific situation. Tax efficiency is a big part of the discussion that I am omitting here.
Pro tip: Go back to the drawing board with your financial plan. If you were over-funding your investments because that was smarter than paying off debt, you might want to review that.
Savings accounts and GICs got a six-pack over the summer
Back when you were in school, was there one person who was an ugly duckling until one summer they got hot? That's GICs, they're so hot right now.
For the first time in my career, I've had to find and research the best savings account and Guaranteed Investment Certificate (GIC) rates.
My favourite line used to be 'GICs are a guaranteed way to go broke slowly.' But now with these paying out over 4%, I have to think twice about whether they fit in a client's portfolio.
Pro tip: Do I think you should sell your investments in the midst of their current loss to buy a GIC? No. A recovery is all but inevitable. But for someone with new low-risk money to invest, these are now viable options along with so many other options.
Lower unemployment is now bad for the economy
Before this year, when we saw lower unemployment numbers, we cheered. It meant more people got jobs. But now there are more jobs available than people to fill them, especially in retail and restaurants. When unemployment is too low it becomes harder to find employees.
Ultra-low unemployment is also bad for everyone else because it tells the Bank of Canada that the economy, like me in my twenties, is too hot and needs to be taken down a notch.
If employers have to raise wages to attract employees, it gives more money for people to spend on limited goods which worsens inflation. The worse inflation is, the higher interest rates have to go to bring it back down. Economists call this the 'Wage-Price Spiral'. If you think your mortgage is expensive now, it can get worse if the economy doesn't cool.
Getting a raise is cool until everyone is doing it. Then it's inflation.
House prices have stopped rising
I am gun shy to comment on housing because for a good chunk of my career I was pessimistic that house prices would continue to rise at 8% per year. Back then I had naïve ideas like, "governments care about young people and housing affordability," and "interest rates can't stay near zero for much longer."
I've since smartened up and realized just how focused government policy is on winning the next election at the expense of long-term planning. Excuse me while I cash my license plate rebate cheque on the way to the 12-hour lineup at the ER.
If you calculate the value of a one-bedroom suburban condo rising by 8% per year, the price balloons to over $10 million in a generation. Does that sound reasonable?
So, here we finally are. While it might not feel great that the value of your house or rental is declining, this shows that your kids and grandkids may not be forced to live in your basement forever.
Many of my clients (including my parents) immigrated here from countries where breaking into the middle class and buying property is nearly impossible. Property has to be inherited. No one wants that as the norm in Canada. If you want your kids/grandkids to be able to afford a roof over their heads, then a decline in house prices should be welcome.
Owning rental properties may not be worth it for a while
Basically, the above but applied to rental properties. What happens if the growth of your investment is slow for a long time because rates rest at a higher point?
If house prices were rising in the 8% range when mortgages were in the 2% range, what happens to house price growth if mortgages are above 4% for the foreseeable future?
To be clear, I don't know where rates are going, but 2% mortgages are an exception, not the norm. Mortgages above 4%, are more historically normal.
Pro tip: If the price of your condo only rises by a few thousand per year but the cost of your mortgage goes up by ten thousand, I think you should consider whether to continue down that road. Remember, GICs are paying out over 4% these days with no tenant to manage.
There are more things I can write about but like Tom Brady's career I am guilty of dragging this on for too long.
I'll end on a sincere, positive note. The future for investors is bright if you make the right decisions today. There are far more viable investment options now than there have been since 2008. 0% rates made so many things unprofitable, and pushed people into high-risk assets to try and eke out a return.
We have more viable options to make money today than we have had since 2008. In that way, the financial world isn't upside down. After thirteen long years it's finally right side up. If you know someone questioning what to do with their money in this higher-rate world, please let me know. I'll be nice. I promise.