How to inflation proof your financial plan
2022 has been a challenging year for personal finances. Poor market performance, high market volatility, and geopolitical pressures have combined to make even the savviest of investors worry about their financial situation. Add to this that inflation has peaked at levels unseen since the early 1980s, and it has become imperative to reevaluate your financial plan.
Five strategies to reduce the impact of inflation
1. Review the impact of rising inflation on your financial plan
Inflation is a key assumption in any financial plan. In 2022, Canada’s financial planning regulatory organizations continue to recommend using an inflation assumption of 2.1% based on their long-term assumptions. Your financial planner should model alternative scenarios of your financial plan with higher inflation assumptions (for example 3%, 4% and 5%). By comparing your base financial plan with plans assuming higher long-term inflation assumptions, you can review the differences to better understand how rising inflation could affect the probability of you reaching your goals.
2. Revisit your investment asset mix
Inflation decreases the spending power of the dollars you have saved and coupled with the recent market downturn and increased volatility, you may be at risk of not attaining your financial goals. Your financial planner should review your current asset mix, the suitability of your current investments, and your risk tolerance to determine whether your current investments are well positioned to achieve your financial goals.
3. Review your debt to identify opportunities to reduce debt, and/or interest costs
The Bank of Canada has been steadily increasing interest rates to combat high inflation. As a result, variable rate mortgages, credit cards and certain loans are all costing you more. It is now more important than ever to look for ways to reduce the cost of your debt. Consider eliminating high credit card debt with consolidation loans to reduce your overall interest costs; if you have investments in a non-registered investment account, consider selling, as part of your portfolio review, to pay off any high interest non-deductible debt; and consider whether now is the right time to lock in your variable mortgage loan.
4. Revisit your budget to identify areas where you can reduce costs
With inflation on the rise many of your expenses have increased. In addition, your income may not be keeping pace with inflation. Reducing expenses can free up cash to deploy to either pay off debts or to invest. Places where you may be able to reduce your expenses include consolidating debt to reduce interest charges, postponing major purchases, renegotiating insurance premiums on policies, reducing unnecessary digital subscriptions, and cutting down on non-essentials like entertainment and restaurants by cooking more at home. If your income has not kept pace with inflation, it may be prudent to consider requesting a salary increase, negotiating additional employee benefits, or if that fails given the current employment market, looking for a higher paying position elsewhere.
5. Minimize taxes by taking advantage of available tax deductions and credits
With the cash crunch caused by inflation you should avoid the temptation to reduce contributions to your RRSP, as there may be alternatives for you to free up cash to help fund your RRSP contribution. If you have investments in your TFSA but have available RRSP room, you could consider transferring investments from your TFSA with accrued gains to help fund your RRSP. Any of the gains on the transfer from the TFSA are not subject to tax, and you will have access to a tax refund from the additional RRSP contribution.
If you are self-employed there are many deductions and credits available to you that you will want to review with your financial planner. For employees, you could look for ways to maximize your credits for donations and medical expenses before the end of the year, in addition you should be sure that you are claiming the Employment tax credit, Teachers’ school supply tax credit and the Volunteer Fire Fighter credit.
Lastly, if you are paying income tax instalments based on the prior year, do a tax estimate to see if you can reduce or forego your December 15th instalment.
With inflation on the rise, it is now more important than ever to verify that your financial plan is on track. Your financial planner can collaborate with you to update your financial plan and identify which options make sense in your situation.