Updating Your Financial Plan
If we have learned anything in the past year, it is that the world can change in a heartbeat. Going back over the last two years, the effects of the pandemic and the related disruption to global supply chains, labour shortages, sudden spikes in inflation, upward pressure on interest rates, and volatile stock markets, leads one to think about the effects on plans for retirement and other financial objectives that one may have. You may question whether the financial plan that you received three years ago is still relevant or have doubts as to whether your planned year of retirement is still realistic.
Let’s consider inflation.
Up until recently, the inflation rate was at historic lows, around 2%. The most recent reading for the consumer price index in Canada for April was an annual inflation rate of 6.8%. We do not have to go far to see the effects of inflation. It is staring us in the face when we go to the gas station or the grocery store.
The organizations that establish standards for financial planning in Canada, the FP Canada Standards Council and the Institut Québécois de la Planification Financière, recently indicated in their annual publication of financial planning assumptions, that 2.1% is the inflation rate to be used for financial plans, based on expectations for the long term, i.e. for a period over 10 years. They justify this assumption based on long-term historical averages for inflation. At this stage, it is unknown what the inflation rate will be over a 10 or 20-year time horizon and whether the financial planning bodies will recommend a higher inflation rate for financial plans when they publish their assumptions next year.
Though an increase in the long-term inflation rate from 2% to 3% may not seem significant, the purchasing power of a dollar is reduced by 50% over 35 years in the case of 2% inflation, and over 23 years in the case of 3% inflation. To put this in perspective, a 55-year-old would see purchasing power reduced by half by age 90 in the case of 2% inflation and by age 78 for 3% inflation. For someone on a fixed income, the reduction of purchasing power is cause for concern. The golden years may not be so golden!
The Variables of Financial Planning
The inflation rate is just one of the many variables that go into a financial plan. Rates of return on investment assets are another key component. This variable evolves depending on the individual’s objectives and time horizon. An investment policy that considers the allocation between cash, bonds, equities and alternative investments will determine the rate of return to be used. When increasing the inflation rate, rates of return should also be adjusted as higher inflation rates are usually accompanied by higher interest rates and returns on equities. But income taxes will be higher as well!
Tools & Insight to Update Your Financial Plan
What might have been a realistic objective a few years ago, for example, retirement at age 60, might come down to making compromises. This is especially true if there are competing objectives such as funding higher education for one’s children or grandchildren, or helping an adult child with the purchase of a home. The financial planner has the tools and expertise to model these assumptions and scenarios, ask the right questions and provide you with an interactive, value-added experience and hopefully, peace of mind.