Lexicon Financial Group Weekly Update

Monday, January 17, 2022

Looking Back

Inflation, inflation, inflation. That’s seems to be the big bogeyman scaring the markets at the moment. And for good reason. Inflation has the insidious ability to quickly and quietly erode the purchasing power of an investment portfolio and erodes purchasing power. For those that have saved and invested for many years, it’s disheartening to think that their dollars don’t go as far as they had planned. Inflation has an impact on every aspect of our lives – energy costs, food costs, and consequently the cost of almost any good increases in an inflationary environment.

For sure, technology has driven the cost of many things down over the years – think about big screen televisions, for example. But we all need to heat our homes and eat, so there is no way to avoid inflation.

It’s not like we haven’t been talking about inflation for some time – especially when central governments began injecting liquidity into the economy by either purchasing assets directly or distributing pandemic payments to citizens.

It’s now looking rather certain that interest rates will begin to rise sooner than predicted, as a way of dampening inflation. Last week a number of US Fed officials called for interest rates to rise as early as March. The Bank of Canada has already indicated that it plans to raise rates before their April meeting. So while anything can happen, the probability of an interest rate hike has increased.


Looking Deeper

After three consecutive years of above average returns, stocks in the United States, in particular, are trading at very high levels relative to history. This has – in part – been fueled by the same low interest rates that have given rise to an inflationary environment. Investors have not been rewarded for investing in bonds and have sought higher returns in the equity market.

Rising interest rates ultimately slow economic growth and expansion. That’s because at some stage investors will choose the (now) higher yielding fixed income investment or bond instead of putting capital at greater risk in the equity market. This is the standard trade off between risk and return. But, any change to underlying economic levers almost always results in increased volatility, as market movers, institutional investors and indeed individual investors adjust their portfolios accordingly.

What’s important for individual investors is that they don’t lose sight of the fact that for them, their investment portfolio is a tool to help them achieve their individual economic goals. Investing isn’t a game, there is no scoreboard. For many, a good investment strategy is to find the way to achieve financial objectives while taking the least amount of risk possible. This has not been the case over the past few years – although volatile – have benefitted investors who have taken on excess risk in their portfolios.


Looking Beyond

I can’t stress enough the importance – especially for long-term investors – of spending the appropriate amount of time determining a long-term investing strategy. One way that we’ve been helping some investors deal with the volatility of the market is by separating their investment portfolio into different accounts for different purposes.

For example, a client may choose to split their account three ways. The first – a “spending account” is invested in a highly conservative manner, and holds enough assets to cover three years of day-to-day spending. The objective of this account is simply preservation of capital, ensuring that money is available when needed. In this instance, the portfolio is specifically designed to insulate itself from day-to-day market risks.

A second account – perhaps even the bulk of the client assets – are invested in a more moderate strategy with a medium-term time horizon. That’s because the assets here are used to top-up the spending account on a periodic basis.

Finally, there may even be an account dedicated to the client’s estate. If it is intended for their heirs, the account may be invested very aggressively, since it is intended for long-term use.

On average, the overall client may indeed be moderately invested, but by positioning different accounts for different purposes, a long-term strategy helps manage and deal with the emotions that are always present during market volatility. Framing accounts in this manner does inure them from the risk of capital markets, but it helps put the risks into context.


Further Reading

Markets & Investing – Raymond James

Historical Parallels to Today's Inflationary Episode

Why 7% Inflation Today is Far Different than in 1982


Further Listening

The Great Inflation and How Paul Volcker Beat It

The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.