Some of your clients may be resting easy in the belief that their inflation-indexed government retirement benefits and private pension plans will keep their purchasing power intact over time. However, many financial advisors are finding this isn’t necessarily the case.
“Many of my clients keep needing extra infusions of income, even though their [private] pension, Canada Pension Plan and old-age security income is indexed to inflation,” says Christine Butchart, senior financial advisor and branch manager with Assante Capital Management Ltd. in Hillsburgh, Ont.
As a result, Butchart and other advisors are employing different rates of inflation in their projections for clients’ income and expenditures. The reason for this is evident in a close analysis of Statistics Canada’s consumer price index, the most common measure used for changes in inflation, which reveals that inflation experienced by your clients may be higher than the CPI initially suggests.
The CPI measures price changes for a basket of goods and services, based on average spending by Canadians in a particular year. (The current basket of goods and services is based on 2009 data.) But this basket contains mutually exclusive expenditures, such as both rent and the cost of owned accommodation, and home heating costs using both fuel oil and natural gas.
As there can be large differences in the price increases for these expenditures, the inflation experienced by individuals can vary significantly. For instance, in August, the cost of fuel oil was 130.9% higher than it had averaged in 2002, while natural gas was up by only 13.6%. And, although the differential is not nearly as large for shelter costs, the cost of owned accommodation was up more than twice as much as rent, at 28.8% vs 12.2%, respectively.
Another important factor is that StatsCan doesn’t include price increases associated with quality improvement. For example, when automatic defrosting became the norm in refrigerators, the price would have gone up.
Similarly, cars are always being “improved,” either to enhance the appeal of the vehicle or because of new regulations related to safety or environmental emissions. In August, the purchase price of a car in the CPI was 11.4% lower than in 2002. But that doesn’t mean that people are paying less for cars today than they were nine years ago; indeed, they may be paying a good deal more.
Furthermore, the costs of operating a car have increased at a much faster pace — and that is likely to continue. In August, these expenses were 60.7% above the 2002 average, with increases of 81% for gasoline, 59.4% for insurance premiums and 57% for parking fees.
The cost of city bus and subway transportation also has gone up by 37.5%, a faster pace than overall inflation but much less than operating costs for cars.
Inflation rates also differ across the country. The CPI for British Columbia was up by 16.9% in August vs the 2002 average (see table), while it was up by 26.3% in neighbouring Alberta. Nevertheless, CPP, OAS and pensions indexed to the Canadian CPI would have increased by the same 17.8% for residents in both provinces.
It’s important to note that CPP, OAS and many indexed pensions are adjusted using the increase in what’s known as “core” inflation, which leaves out food and energy costs on the theory that these prices can fluctuate considerably within short periods of time and, as a result, don’t truly reflect underlying inflation.
It is certainly true that core inflation doesn’t gyrate as much as the overall CPI. But it’s also true that in recent years, core inflation has mostly been lower. In August, the core CPI was 17.8% higher than in 2002, while overall inflation was up by 20.3%.
That difference may not seem like such a large spread over nine years, but it can be significant when your clients are trying to make ends meet. They still have to pay the higher food and energy costs, so they will have to find other sources of income, dip into their savings or cut spending in certain areas to make ends meet.
It’s likely that overall inflation will continue to be higher than core inflation because the anticipated continued strong growth in emerging markets. As incomes rise in those regions, both consumers and businesses will consume more energy and consumers will buy higher-quality grains and meats, which will keep demand high for Canada’s oil and agricultural products.
All this suggests that you would be wise to use a somewhat higher inflation adjustment on the spending side than on the income side when doing projections for your clients.
To be safe, Butchart assumes 2% inflation on the income side — the Bank of Canada’s target for inflation — and a higher 3% on the spending side in her projections. Furthermore, she’s considering increasing the latter to 4% because even when she uses 3%, clients keep needing additional income.
Similarly, Barb Garbens, presi-dent of B L Garbens Associates Inc. in Toronto, also uses 3% inflation on the spending side but just 1.5% for government benefits and 2% for private pension income in her projections.
Norman Rashkowan, executive vice president, investments, and chief North American investment strategist with Mackenzie Financial Corp. in Toronto, says it would “not be unreasonable” to use 4% for the spending side of long-term projections.
Using higher projections for expenditures should be particularly helpful in two key areas in which the CPI doesn’t provide good information: education and medical care for the elderly.
The CPI includes tuition fees, but this is an average across the country; both the various levels of tuition fees and the increases in these fees differ widely. The CPI shows a 41.1% increase between 2002 and August 2011, but the relevance of that average is questionable for advisors projecting future tuition costs for clients planning to pay for their children’s education.
When you’re trying to figure out how much to put aside for your clients’ children’s education, it may be best to look at the current level and the history of increases in tuition at the universities your clients think their children may want to attend, says Gaétan Ruest, assistant vice president, strategic investment planning, with Investors Group Inc. in Winnipeg.
Average tuition fees for 2011 range from less than $3,000 in Quebec and Newfoundland and Labrador to more than $6,000 in Ontario.
Nursing-home fees are not included in the CPI. These also vary widely, from about $1,000 a month in Quebec and $1,400 in Alberta to almost $3,000 in B.C., Nova Scotia and Newfoundland and Labrador. These fees are regulated and are for only room and board; medical care is covered by provincial governments.
There is no Canada-wide data on home care, retirement homes or the costs of private nursing homes, whose medical care is also paid by government. It is these costs that have soared — they can be very high, at $4,000, $5,000, $6,000 or even more a month. If your clients may want such care, they may want to consider long-term care insurance. IE