For the first time, the younger generation is living in a world of rising interest rates and high inflation. Over the past two decades, many of us have grown accustomed to low interest rates due to slower economic growth and low inflation. Now, to try and temper persistently high inflation, the central banks have taken an aggressive approach to hiking rates.
As this is the first time that many younger people have experienced rising rates and high inflation, here are a few thoughts on helping them prepare for this changing landscape.
First, Why Are the Central Banks Raising Rates?
Today, demand has exceeded supply for many goods and services, which has pushed prices upward. This has been attributed to actions taken during the pandemic, including unprecedented stimulus and supply chain issues from the shutdowns, as well as the conflict in Ukraine. By raising interest rates, it encourages saving and discourages borrowing by making it more expensive, which in turn helps to reduce spending and demand. This will help to bring down the rise in prices, or inflation.
An Opportune Time to Focus on Personal Finances
Due to many years of predictably low interest rates, it was easy to assume debt with little worry. However, access to credit cards, lines of credit and even mortgages may land some individuals in difficulty with debt. With rising rates, borrowing is now becoming increasingly more costly and some individuals may not have been prepared for rates to rise as quickly as they have. As such, for many young people, a focus on personal finances may be a good starting point.
Pay down debt. If there are debts to service, there may be the opportunity to prioritize which debts should be paid down first, especially debt subject to high interest rates like credit card debt. It is important to understand the terms of any loan and the effect that rising rates may have. For instance, for a variable-rate mortgage, interest rate increases may lead to higher interest payments or reduce the amount of principal that is paid down. As an example, raising interest rates from 1.5 to 4 percent while keeping the payment amount fixed will increase an amortization period (the time taken to pay down the mortgage) from 25 to 45 years.
Create or revisit a budget. For those who hold debt, it may be beneficial to create or revisit a budget to prioritize paying off debt. Even if no debt exists, the effort of sitting down to map out income and expenses each month can be revealing, especially in this period of high inflation where the cost of most goods/services has increased. This may also uncover certain spending habits that may need adjustments and help to better allocate where funds go.
Encourage saving. With access to easy debt, the notion of saving has been overlooked by many younger people. The lack of a saving strategy has implications for investing: without capital, there can be no investment. However, a simple example of how saving can lead to future wealth may be worth sharing: A young person who saves and invests $5,000 each year at an annual rate of return of five percent will be a millionaire in 50 years, assuming no taxes.
How can younger people be encouraged to save? It may be a simple exercise of looking for potential reductions in consumption that can lead to worthwhile savings. Or, it may involve practicing “paying yourself first” by setting aside a portion of a paycheque that
will be put away for the future. With higher interest rates, low-risk savings vehicles that have been overlooked in the past may also start looking more attractive, and many younger people may not be aware of these products — many five-year guaranteed investment certificates (GICs) now have rates in excess of four percent.
We Can Assist
These are just a handful of discussion points to help generate a dialogue. If you need assistance with these conversations, or if you are in need of tools or worksheets to help budgeting and encourage saving, please call the office.
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