The impact of inflation can be seen in practically everything you do these days. The petrol you buy, the groceries you purchase and the food you eat, to cite a few instances. Ask people about inflation and their reaction is they will do what they can to cut expenses. That sounds logical, if groceries and petrol for instance have become expensive, then you must judiciously cut down on their usage to reduce the pain. But what about your investments, do you also cut down on your investments so that you can save on your ‘investment bill’?

Quite the opposite. Since investments are an asset and not an expense like petrol and groceries there is scope to increase your investments in areas that can help you beat inflation. Beat inflation? Is that possible? We can show you how that is possible.

What is inflation?

First let’s understand exactly what inflation does to you or to put it more precisely to your money. Let’s assume you could buy 1 litre of petrol for Rs 10 (1 litre = Rs 10). As crude oil supply turns volatile, petrol prices rise. Now 1 litre of petrol no longer costs Rs 10, it has appreciated to Rs 12 (1 litre = Rs 12). In one stroke the purchasing power of the rupee has fallen from 1 litre = Rs 10 to 1 litre = Rs 12, or to put it differently the real value of your rupee has fallen. In other words, the Rs 10 that used to get you 1 litre (1 litre = Rs 10) will now get you 0.8 litre (0.8 litre = Rs 10).

As an investor, you must invest in a manner so that the return on your investment compensates you for the falling value of the rupee and still leaves you with considerable surplus. In financial parlance this is referred to as the ‘real return on your investment’, i.e. return after factoring in inflation.

Where you should invest

1) Equities
If you have the appetite for risk, then equities/stocks is a must-have in your investment portfolio if you want to successfully counter inflation. It has been proven time and again how, over the long-term, equities can be an effective foil for inflation. Sample this – over the last 10 years, the BSE Sensex has appreciated by 14.7% CAGR (compounded annualised growth rate). On the other hand, inflation has averaged about 5.6% CAGR. In effect, by investing in the BSE Sensex over 10 years you would have outperformed inflation by a significant margin (9.1% CAGR).

Of course, investing in equities is easier said than done. More than the money, it involves ‘investing’ a lot of time and effort, which is beyond most lay investors. Help is at hand, for such individuals in the form of equity funds. Investing in equity funds not only saves you time and effort, but also reduces the risk of investing in equities through superior diversification.

  
2) Short-term deposits and funds
If you don’t have the appetite for equities, then short-term deposits/debt funds will prove ideal for you. During inflationary times, avoid investing in longer-dated debt investments. This is because inflation is usually countered by Central Banks by raising interest rates – this actually happened last week in the Indian context. When rates are raised, issuing banks/institutions raise the coupon rates on their offerings. Investors in existing securities witness a fall in their investment value, while fresh investors will get the opportunity to earn a higher coupon rate. So when it appears that interest rates could rise, invest in short-term deposits/debt funds so as to be sufficiently liquid. This way when interest rates do rise, you will be in a better position to benefit from the situation.

3) Gold
Commodities like gold are a hedge against inflation. This is mainly because the factors that affect the prices of gold are different from those that impact the prices of other assets like equities for instance.

 Gold is a storehouse of value. When uncertainty afflicts global markets, investors prefer to take refuge in gold because in times of inflation (i.e. fall in purchasing power), gold prevents erosion in the value of the purchasing power.

Apart from the aforementioned assets, property and variable rate fixed deposits are other alternatives that investors may want to consider during inflation. The moot point is that the investment landscape offers plenty of options to investors that can insulate them against inflation. The onus is on the investor to make the most of these opportunities depending on his risk profile and investment objectives.

Add Comments