If you’re holding a lot of bonds, GICs or savings, one of the biggest financial questions to be answered in 2021 is the direction of inflation.
The November, 2020, tally of inflation came in at 1 per cent on a year-over-year basis, which reflects the effect of the pandemic. From 2010 through 2019, inflation averaged 1.7 per cent.
But even at today’s modest rate, inflation is a problem for people holding bonds, guaranteed investment certificates and savings. Simply put, people may be losing money on an after-inflation basis. Five-year Government of Canada bonds yield about 0.5 per cent, five-year GIC rates are commonly below 1 per cent at major financial institutions and savings rates can be as low as 0.05 per cent.
Brace for worse in 2021. A recent forecast from Capital Economics calls for an inflation rate above 2 per cent for most of next year, and then a dip in 2022. Economic activity will be subdued next year, even with a vaccine for COVID-19 being distributed. But vast amounts of government money have poured into the economy to sustain activity, and that could prove to be inflationary.
Rising inflation typically means rising rates. Rates in the bond market could move higher next year, but some economists expect the Bank of Canada will keep its trendsetting overnight rate at just 0.25 per cent throughout 2021. If this happens, we may see even worse after-inflation returns for supposedly safe money parked in bonds, GICs and savings. Inflation ticks higher while savings rates more or less hold steady.
Bonds have a role in portfolios as a counterbalance to much more volatile stocks, and savings accounts have a role as a safe haven for money you might need at a moment’s notice because of a financial shock. So don’t give up on either bonds or savings. Instead, push a little harder in 2021 to find the best possible rates.
GICs from alternative banks and credit unions offered rates as high as 1.7 to 1.9 per cent in late 2020, and savings accounts paid from 1.5 to 1.8 per cent at most. That’s better than the November inflation rate by a decent margin, with enough breathing space to accommodate a small increase in the cost of living to come.
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