What's inflation and what causes it?
Over time, prices tend to go up—which is called inflation. Because of inflation, how much you spend on everyday items changes from year to year, even if what you buy doesn’t. And when costs go up, people and businesses can’t buy as much as they could before.
Inflation can be caused by changes in supply, demand, and costs:
- When too many people want to buy something, demand increases, and prices go up.
- When there’s not enough supply of something people or businesses want, they’re willing to pay more.
- When the cost of doing business—such as the price of raw materials or wages—goes up, companies often pass along these increases to their customers.
Inflation hurts your future purchasing power
When people say a dollar doesn’t go as far as it used to, they’re talking about inflation and the purchasing power of money.
A dollar bought more in 2001 than 2021; in other words, it had more purchasing power. Let’s say that in 2001, you went to the grocery store and spent $100 to fill your basket. In 2021, it would have cost you $143.52 to fill your basket with the same items.1
The cost of goods has increased
Source: rateinflation.com, 2022.
Inflation is stated as an annual rate. Between 2001 and 2021, annual inflation rates ranged between 0.3% and 3.4%—or an average of almost 1.9% per year. That doesn’t sound like so much, but over 20 years, inflation increased your $100 of groceries by more than 43%.
Inflation also affects your retirement savings
As you think about how much you need to save for retirement, make sure you include inflation in your plan. You know how much you’re spending now, either because you follow a budget or because you just “have a feel for it.” So, to figure out your retirement spending, think about how your life will be different and how that will change your spending.
A helpful way of looking at your spending is to break it out into two categories: basics and nonessentials.
1 Basics are the things you can’t live without, such as groceries, housing, a car, gas, heat, and insurance. The price of many basics will depend on where you plan to live in retirement, so if you plan to move, find out the difference in the cost of living.
2 Nonessentials are the fun stuff—what you’ll do in retirement, such as eating out more, joining a club, or spending money on things such as hobbies, travel, entertainment, and other leisure activities.
Because of inflation, pretty much all of your expenses will likely be higher—both basics and nonessentials. You can use history to help you estimate how much extra you’ll need to have available to cover inflation. If your retirement is 20 years away, and you use the 2001 to 2021 example as your guide, your $143.52 basket of groceries could cost you $205.97. Are you saving enough to be able to afford the life you want in retirement, or should you save a little more in your Registered Retirement Savings Plan now to give it time to grow as well?
Include inflation in your budget for today and tomorrow
Although you can’t predict how much prices will increase over time, you can safely expect that they will increase over time. Between 2001 and 2021, we experienced years of slow to moderate inflation, then along came the pandemic and the many economic disruptions that accompanied it, and inflation in 2022 has been very high. Take a look at your budget today to see where you may need to adjust your spending to account for the declining power of the dollar. And take a moment to make sure you’re saving enough to afford the life you want in retirement.
1 "Canadian Inflation Rates: 1990 to 2022," rateinflation.com, 2022.
The commentary in this article is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.