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. This means that the number of goods that Rs 100 can get you today will reduce in a couple of years.
Rising price levels, in other words, inflation, diminishes the value of money with time and beating inflation with your investments becomes essential.
Read on to find out more on how to beat inflation.
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 which returned 4% in the next year. 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%.
Your return on investment is lesser than the inflation rate which basically nullifies the returns you earned.
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 that have a greater chance of being equivalent to or more than the rate of inflation tomorrow. When picking the best investments for inflation protection investors should always research well on their own risk profile and goals.
An advice that always comes in handy: ‘Do not put all your eggs in one basket’. A few investments may appear to give really high returns, especially equity-oriented investments but they also come along with higher risk levels. Diversify accordingly, keeping in mind your goals, risk levels and inflation.
Here are some of the investment options in India and let’s see if they have been able to beat inflation in the past. Do keep in mind that historical performance is not always indicative of the future trajectory.
Investing in the Stock Market
In the long run, stock markets have beaten inflation. In the shorter term, there are many ups and downs and volatile situations. If we take the example of the year 2020 and 2021. Sensex had reached levels of 25,000 in March 2020 from around 40,000 in January 2020. In 2021, Sensex had already crossed 51,000 levels.
Sensex in a span of 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.
This 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.
Equity Mutual Funds
For investors who do not want to invest in individual stocks can look at equity mutual funds. There are different sub-categories in equity funds as well that can suit the requirements of different kinds of investors. There are equity funds on the basis of market capitalization, sectoral funds, equity funds based on investment strategies, tax-saving funds and more.
The 5- and 10-year returns of most equity fund categories 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 been able to 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 rise in demand for almost anything leads to a rise in prices.
The returns from real estate investments have been around 10% for a 10-year time span. This is on the basis of several media reports and studies published by real estate agencies in India. Investing in real estate requires a huge capital investment, running into a couple of lakhs or crores.
According to RBI’s House Price Index that collects real estate prices across 10 cities, the average return from owning real estate in the past 10 years has been around 11.6%. This is as of October 2020. This is the average returns for the whole of India. In reality, returns may differ from city to city as the levels of property prices depend a lot on geography.
The returns may appear to have beaten inflation however, there are a lot of things to keep in mind when it comes to real estate. For starters, the cost of investing in real estate itself can be huge and most of us will have to take a loan to invest in real estate. The returns should be able to compensate you for the interest you pay on the loan and all other additional costs your 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 key to manage returns, inflation-adjusted returns and capital preservation.
Investing in Inflation-Indexed bonds: 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 ‘index ratio’ to adjust the principal amount against inflation.
Debt Mutual Funds
Debt mutual funds are funds that invest in individual bonds. In a span of 5-10 years, most subcategories of debt mutual funds have returned anywhere between 7-10%. This is across categories. There are more than 10 subcategories in debt funds, all varying in their risk-return potential. Resorting to debt-oriented investment to hedge against inflation depends not just on returns but your risk appetite and goals as well.
Rebalancing your portfolio is basically rearranging the assets in your portfolio according to market conditions in the long run. Volatile changes in inflation rates, a change in financial goals and many other factors may require you to rebalance your portfolio. A portfolio that you created in 2015 keeping in mind the economy and inflation rates may not work for you in 2021. Hence an important component of hedging your portfolio against inflation is to revisit your portfolio and make changes, only if required.
Inflation is a cascading long-term socio-economic phenomenon that affects people on an individual level. 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 not impossible to beat inflation but it is also important to realign your portfolio time and again to readjust according to current inflation levels.