Is Inflation Eroding Value of Your Investments? Learn How to Rebalance Your Portfolio

Jun 03, 2022

Listen to Is Inflation Eroding Value of Your Investments? Learn How to Rebalance Your Portfolio

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Most individuals understand that inflation increases the cost of living and decreases the value of our hard-earned money earned. A rupee today will not buy the same amount of goods and services five years from now. And in reality, inflation affects all areas of the economy. It is a major concern for everyone --ranging from government, companies, consumers, and investors. Over time, it weighs down on our investment returns.

The headline CPI inflation rate in India increased to 7.79% for April 2022, it has rallied by 344 basis points from a level of 4.35% in September 2021. Surging inflation and RBI counter monetary policy action in the form of rate hikes are expected to slow India's economy. People would turn cautious and spend less on goods and services. Elevated international oil, due to the Russia-Ukraine conflict is already causing havoc. It has cascaded inflationary pressures on all commodities.

For investors, beating inflation appears to be an intractable challenge. However, there are ways to shield your hard-earned money from the impact of inflation.

In the Indian equity markets, volatility has intensified and there are headwinds in play. To ensure that your investments do not erode at a faster rate as a result of high inflation and market volatility, you need to review your portfolio and assess where you stand.

To stay ahead of inflation and manage the risk involved, you require a combination of investments to generate the best possible inflation-adjusted returns, known as the real rate of returns. You simply can't skew your investment portfolio to just one asset class. If you have been doing that, consider reviewing and rebalancing the portfolio to set your allocation and investments right. As you may know, rebalancing is a process, wherein you set your asset allocation and investments therein optimally to address the prevailing market conditions. This may include divesting from over-allocated and/or underperforming assets, plus finding better alternatives to clock optimal inflation-adjusted returns. By doing so, you gain a better of your portfolio.

Here are a few ways you may consider rebalancing your investment portfolio:

1. Overview of Your Portfolio Holdings

Look at all your holdings. A majority of Indians still prefer holding a major part of their portfolio in traditional investments such as Bank Fixed Deposits (FDs), Small Saving Schemes (SSS), and investment-cum-insurance products. You need to look beyond these traditional avenues to include better wealth-creating ones, such as stocks and mutual funds.

The historical data reveals that Bank FDs are not a way to generate inflation-beating returns. In the present times when inflation is spiralling, and the interest rate on FDs (and SSS) is low; you are yielding a negative real return. It is not helping you to accomplish your envisioned financial goals.

Also, while you have a penchant for gold, invest in it the smart way. Consider investing in Gold Exchange Traded Funds (ETFs), Gold Saving Funds, and/or Sovereign Gold Bond schemes--the smart way of investing gold --and not merely hold gold in physical form, which carries an additional holding cost. In times like these, where is uncertainty surrounding; gold will display its trait of being a safe haven, a hedge against inflation, and command a store of value.

Is Inflation Eroding Value of Your Investments? Learn How to Rebalance Your Portfolio
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2. Ensure Tactical Asset Allocation

Assess the proportion of your holdings in equity, debt, and gold. Is it the best suited for you considering your age, risk profile, investment objective, the financial goals you wish to address, and the time in hand to achieve those goals. In essence, your asset allocation should be tactical, whereby you achieve two competing objectives: optimal returns and low risk.

For example, if the end goal is planning for your child's higher education needs, considering that inflation in education is on a higher side than CPI inflation, you need to allocate a higher portion of the investible surplus to equities and start SIPs in a worthy Value Fund, a Large-cap Fund, a Flexi-cap Fund, and Mid-cap Fund. Potentially the overall returns you shall earn from these would help you counter inflation and accomplish the goal. You cannot simply invest in an ad hoc manner; it may not help you realise the envisioned financial goal.


3. Rebalancing for Diversification

The most basic form of rebalancing is maintaining the diversification of a portfolio. Like Asset Allocation, diversification within each asset type is the key tenet of investing. It helps cushion the risk and clock efficient real returns.

Having said that, never add too many investment avenues within a respective asset class. Over-diversification does not bring any additional benefit. On the contrary, it dilutes the possibility of earning efficient real returns.

Keep in mind, that diversification should help minimise risk while maximising return. Thus, you need to rebalance the portfolio from a diversification point of view whereby its true benefits kick in. Keeping inflation-hedged asset classes on your watch list and using an opportune time, enables clocking appealing real returns.

In this day and age of financial engineering, exotic financial products, structured products, alternative investments, and bitcoins (which do have underlying cash flow) are not suitable for everyone. Hence, do not blindly follow someone who is investing money in such financial products. Keep in mind that, investing is an individualistic exercise. Follow the asset allocation that is best suited for you.

How often should you rebalance and review your portfolio?

Review your portfolio at least once a year, or perhaps once every six months, to analyse where you stand in the wealth creation journey.

That said, only rebalance it if you believe your allocations have strayed significantly from where it is supposed to be, and if the investments are not able to cope with the inflation. Frequent churning, performance chasing, and liquidating your investments due to rising inflation or high volatility led to sub-optimal gains. Avoid making hasty investment decisions based on forecasted short-term economic changes. Make sure any inflation-hedging tactics you utilise are aligned with your overall financial plan and will help you achieve your financial goals. To keep your investment portfolio inflation-proof, thoroughly examine the risk and reposition your portfolio by seeking the help of a SEBI-registered investment adviser.

Periodic portfolio review and rebalancing help you gain better control over your portfolio and assess whether or not you are on track to accomplish the envisioned financial goals by countering inflation.

As a result, it is critical to develop sound investment strategies and make well-informed investment decisions.

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Happy Investing!


Warm Regards,
Mitali Dhoke
Jr. Research Analyst

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