Saving money can be as challenging as earning it. It is a known fact that the value of money, more often than not, decreases with time. It means the number of goods Rs 100 can get you today will reduce in a few years.
Simply put, inflation is the rising cost of everything around you, followed by a gradual decline in the buying power of your money. To understand this further, evaluate the cost of any item in your home you have purchased in the last few years and how that cost has risen.
Inflation is measured by considering price increases in staples often purchased by the general public. It means that your household's inflation rate may vary.
Therefore, what investment rules must retail investors adhere to keep inflation at bay?
Inflation is measured using two indices: the consumer price index (CPI) and the wholesale price index (WPI).
These two measures assess the inflation rate at the retail level by considering expenses such as food, education, healthcare, electronics, and other standard costs that a routine consumer would have to pay for, as well as the cost of goods sold in bulk, or wholesale, to merchants and vendors.
The CPI considers 260 commodities. It does this by tracking the prices of sample goods every month to map price changes.
WPI takes into account 697 commodities. These commodities include raw resources, manufactured goods, and power and fuel. The Ministry of Commerce and Industry determines a collective price monthly to determine the WPI.
Beating inflation means earning higher returns from an investment than the inflation rate in the economy. If the rise in price levels is more than the returns you are getting, your returns will get nullified.
Let’s take a small example.
Say you invested Rs 100 in an investment that returned 4% in the next year. So the value of your investment becomes Rs 104. On the other hand, let’s assume that the inflation rate in the economy is 5.5%. So your investment return is less than the inflation rate, nullifying your earned returns.
Due to various reasons, the purchasing power of money decreases significantly every year. As a result, the price of commodities increases every day. This economic phenomenon is called inflation.
One of the best strategies to beat inflation is to invest in things or products with a greater chance of being equivalent to or more than the rate of inflation tomorrow. Therefore, investors should always research their risk profile and goals when choosing the best inflation protection investment.
Advice always comes in handy: ‘Do not put all your eggs in one basket.’ A few investments may appear to give high returns, especially equity-oriented assets, but they also have higher risk levels. So diversify accordingly, considering your goals, risk levels, and inflation.
Saving is frequently thought to be sufficient when it barely gets you by. Investing allows you to expand your savings and turn them into an asset that grows in value over time. It, however, occurs only when investing is done correctly.
If you invest in tools that pay a lower interest rate than the inflation rate, your investment will fail in a race against inflation. Alternatively, if you increase the returns on your savings using the correct investment instruments, you can stay up with inflation and have spare funds after settling your bills.
Here are some of the investment options in India, and let’s see if they have been able to beat inflation in the past.
In the long run, stock markets have beaten inflation. However, in the shorter term, there are many ups and downs and volatile situations. Let's take the example of the years 2020 and 2021. Sensex reached 25,000 in March 2020 from around 40,000 in January 2020. In 2023, Sensex has already crossed 60,000 levels.
Sensex, in 5 years, has returned over 88% CAGR as of April 15, 2021. The performance of individual stocks may differ from the performance of benchmark indices.
It shows that in the long run, stock markets bounce back. Risks and losses even out. Goal-based and well-researched stock market investments can help to beat inflation.
Investors not wanting to invest in individual stocks can look at equity mutual funds. Different subcategories in equity funds can suit the requirements of different kinds of investors.
For example, there are equity funds based on market capitalization, sectoral funds, equity funds based on investment strategies, tax-saving funds, and more.
Most equity fund categories' 5- and 10-year returns were above 10% as of April 2021.
Gold is considered to be a 'safe haven' by experts around the world. It is used as a hedge against inflation because the increase in gold prices and the returns thereof have offset inflation in the past. Gold is a commodity and not a paper asset.
A study by World Gold Council says that for a 1% rise in inflation, there is a 2.6% rise in gold demand, and a surge in demand for almost anything leads to an increase in prices.
The returns from real estate investments have been around 9% for ten years, based on several media reports and studies published by real estate agencies in India. However, investing in real estate requires a considerable capital investment, running into a couple of lakhs or crores.
According to RBI's House Price Index, which collects real estate prices across ten cities, the average return from owning Indian real estate in the past ten years has been around 9% as of 2023. However, in reality, returns may differ from city to city as the levels of property prices depend a lot on geography.
The returns may have beaten inflation. However, there are many things to remember regarding real estate.
For starters, the cost of investing in real estate can be huge, and most of us will have to take a loan to invest in real estate. Therefore, the returns should compensate you for the interest you pay on the loan and all other additional costs you're incurred to get the property in the first place.
Bonds or debt funds that invest in bonds are linked closely to interest rates in the economy, which works closely with the inflation rates.
If inflation rises, interest rates rise. Interest rates and bond prices move in opposite directions. Hence bond prices will fall in this case. Bond funds can lose value in inflationary environments. But diversification is critical to managing returns, inflation-adjusted returns, and capital preservation.
Inflation-indexed bonds (IIP) issued by the government of India are specifically meant to give investors returns beating inflation. The RBI, which supervises the bond on behalf of the government, uses an 'index ratio' to adjust the principal amount against inflation.
Debt mutual funds are funds that invest in individual bonds. In 5-10 years, most subcategories of debt mutual funds have returned anywhere between 7-10% across all categories.
There are more than ten subcategories in debt funds, all varying in their risk-return potential. Resorting to debt-oriented investment to hedge against inflation depends on returns and your risk appetite and goals.
Rebalancing your portfolio is rearranging the assets in your portfolio according to market conditions in the long run.
Volatile inflation rate changes, financial goals, and many other factors may require you to rebalance your portfolio.
For example, a portfolio you created in 2015, considering the economy and inflation rates, may not work for you in 2023. Hence an essential component of hedging your portfolio against inflation is to revisit your portfolio and make changes only if required.
While we all start somewhere, it is only normal to want assistance occasionally. Hence, if you need clarification on how to go about planning your investments to fight inflation, it's best to speak with an expert.
A licensed financial advisor can help you put your assets to good use and ensure you can do more than keep up with the increasing living costs.
Inflation is a cascading long-term socio-economic phenomenon that affects people individually. But it is not new. Various market strategies have developed over time to beat inflation.
Mainly, demand-pull or cost-push situations are to blame for inflation. It is possible to beat inflation, but it is also essential to realign your portfolio repeatedly to readjust according to current inflation levels.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.
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Research Analyst - Himanshu Sinha