High rates don’t just impact bondholders. Companies that used relatively cheap borrowing costs to expand during the past 10 years also felt the sting of rising rates. The NASDAQ Composite Index, which mostly represents technology stocks, fell more than 32% in 2022 as interest rates soared.
There were a few bright spots during the rising-rate environment of the past few years, however, the first being the modest guaranteed investment certificate (GIC). At the start of 2022, you could buy one-year GICs paying 1.5% interest. By the end of that year, one-year GICs were paying more than 5% interest. Five-year GICs saw a similar surge in rates, moving from around 2.5% to 5% by the end of 2022.
Why persistently high inflation is concerning for investors
Like the Bank of Canada, other central banks around the world hiked their benchmark interest rates in an effort to return inflation to the low and predictable levels we’ve become accustomed to over the past 30 years.
Both the Bank of Canada and the U.S. Federal Reserve have stated that persistently high inflation is more of a threat to economies and livelihoods than the short-term pain of increased interest rates and a cooling economy. They want to avoid a repeat of the painfully high inflationary period of the 1970s at all costs, which is why rates climbed as high as they did and stayed there until central banks were confident that inflation had been squashed.
That seems like the sensible choice, given that stock and bond prices are all about future expectations. Low, predictable inflation allows businesses and consumers to confidently make plans for spending and reinvestment. Persistently high inflation brings uncertainty, which leads to volatile swings in asset prices.
The best-case scenario is a soft landing, in which inflation comes back to its target rate of 2% without tipping the economy into a recession.
What investors can do to protect retirement savings
If you’re retired, you’re approaching retirement or you’re still several years out but are planning your retirement finances, the high inflation scare of the past few years might be keeping you up at night. How can you minimize its impact on your purchasing power now and in the future?
The best defence is diversification, according to Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital in Ottawa. On an episode of their investing podcast, Rational Reminder, Felix said that investors can decrease the risk of their entire portfolio having zero or negative real returns by holding more sources of expected return in their portfolio. That includes value stocks, domestic and international stocks, and fixed income, if it makes sense in the portfolio.
