Your investment avenues during inflationary times   Aug 16, 2012

In times when the global economy is experiencing a gloom, and sending its ripples to the Indian economy, there is uncertainty looming around. In India along with slump in economic growth rate, price rise (commonly known as inflation) has been major concern for the central bank as well as citizens of the country. And amid this situation of slump in economic growth and stiff inflation, investors are often left to wonder, as to which investment avenue could effectively help in creating wealth after accounting for inflation. To simply put, clock a post-tax rate of return on investments, over and above the inflation rate.

Through this article we intend guiding you valued investors’ on how you should approach your investments during inflation times.

Primarily, while making fresh investments, or evaluating your existing investment portfolio in inflationary times you need to be cognisant about:

In case if you are deriving a negative real rate of return on your investments, those investment avenues should be a strict “no-no". It is noteworthy that the real rate of return refers to the return which one obtains after accounting for inflation rate. To quickly calculate the same, one can use a simple formula which is:

Nominal Rate earned on the security - Inflation rate

Alternatively, you could also use the scientific formula to obtain the precise real rate of return; which is:

{((1 + return on the security)/(1 + inflation rate) -1) x 100}

Also one needs delve into the post-tax returns to consider investment avenues, to obtain meaningful returns after meeting your tax obligation for the returns earned.

So, where should you invest?

Well, there are investment avenues galore. In the backdrop of gloomy global economic environment, while many of you may display a trait of being risk averse, and might have penchant towards investing in fixed income instruments such as fixed deposits, bonds and debt mutual funds; we recommend you to adopt caution while investing in them, as they may not always aid you in achieving meaningful returns (post-tax) and kick the inflation bug.

If your age, income, risk profile and nearness facilitate you to invest in risky asset classes, you ought to gather courage and invest in the following investment avenues to kick the inflation bug over the long-term.

  1. Equities:

    The rollercoaster movement of the equity markets (in the last four years) have certainly brought shivers down the spine of many investors. But one needs to recognise that if one invest in equities for the long-term and refrains from trading, you could beat the inflation bug and clock appealing post-tax return. Over the last 10 year the Indian equity markets (BSE Sensex) has delivered a stunning CAGR of 19.3%, while inflation has averaged at about 6.0% - 6.5%.

    To invest in equity, you could either opt for direct equity investment (i.e. through stocks) or invest through equity mutual funds. Both have their own pros and cons. If you as an investor have profound insights about stocks and investing, with the requisite time and skill to analyse companies, then you can surely begin independent stock-picking. But, in case if you lack any one or all these pre-requisites, then you will be better-off by investing in stocks through equity mutual funds, since they offer several important advantages over direct stock-picking, which are:

    • Superior diversification
    • Professional management
    • Economies of scale
    • Lower entry level
    • Liquidity
    • Innovative plans/ services for investors

    But while investing in mutual funds too, care should be taken to select winning mutual funds, and prefer the diversified equity funds over sector / thematic funds.

    It is noteworthy that, over the last 10 years diversified equity funds on an average have given a return of 22.6% CAGR, whereas a few amongst them haven even outperformed this category average.

    Thus, all those investors who have invested over the long-term have generated wealth in equities, but what is required in prudence, patience and perseverance to beat the inflation bug.

  2. Gold:

    The precious yellow metal - gold too over the number of years has depicted its trait of being a hedge against inflation. When uncertainty has afflicted global markets, investors have preferred to take refuge in gold because in times of inflation, gold prevents erosion in the value of the purchasing power. Amid the uncertainty surrounding the global economy, gold has moved northwards and safeguarded the overall investment portfolio. Over the last 10 years prices have moved up by whooping 415% in absolute terms (i.e. a CAGR of 17.8%) and gold has been a storehouse of value.

    To invest in gold, you can either buy physical gold or invest in Gold Exchange Traded Funds (GETFs) or gold savings funds. But we recommend that you invest in the precious yellow metal the smart way - and that is through GETFs for the host of advantages it has to offer. Alternatively, gold savings funds (which invest in GETFs) can also be considered if you want to invest regularly in gold, as such funds offer you the Systematic Investment Plan (SIP) mode of investing, which provide you with the benefit of rupee-cost averaging and compounding.

  3. Property:

    Property is again a preferred avenue of investment as during inflationary times, property prices too tend to escalate in line with the increase in cost of construction. The only deterrent here is that the minimum amount you need to invest here is substantial and beyond the reach of most investors. Nonetheless, the past trend in prices suggest that investment in real estate or property has been quite rewarding, and can be considered by one as an “alternative investment" in your overall investment portfolio. However, while you invest in property, you ought to adopt caution and look into the following aspects amongst others:

    • Who is the builder?
    • What has been his track record?
    • Has he completed the construction of his projects as per schedule?
    • Visit the site and inspect the quality of construction
    • The rate which he is offering for the amenities offered
    • What would be the approximate maintenance cost?
    • The development in the surrounding area where you intend to invest
    • Title of the property on which the construction is or has taken place (to ensure that it free from any encumbrances and litigation)
    • Has he obtained all statutory permissions
    • In case of a ready property - i.e. newly constructed or a resale property, has a society being formed
    • Is the builder listed or recognised by the housing finance company (in case if you want to avail a home loan facility)

    It is noteworthy that India offers a huge growth potential in the infrastructure space, and thus given that if one lets out the property on rent, appealing rental yields could also obtained, apart from capital appreciation over a period of time.

  4. Inflation linked bonds:

    Such bonds compensate you for the rise in inflation (or the decline in the purchasing power of the currency). Unfortunately in India, the Government so far has not issued any significant amounts of inflation linked bonds. One Capital Indexed bond was issued by the Government of India (GOI) way back in late 1997 which matured in 2002. The bond did not get exciting response from market participants, since the coupons on it were not inflation hedged, although the principal was. The pricing in secondary markets was an issue too.

    But we think that introducing such bonds once again, could be really effective as it would make the Government accountable in a scenario where inflationary threat still persist in the backdrop of rising crude oil prices and deficient and uneven monsoon this year. It is noteworthy that rising inflation would also raise repayment of inflation linked bonds, and also enable the Government to broaden the investor base at retail level, where the participation is still low.

    It is noteworthy that inflation linked bonds offer the following advantaged to investors:

    Moreover, the trading in these bonds could also help the Reserve Bank of India (RBI) while formulating it monetary policy.

The end note…

Thus to conclude, while there are host of investment avenues to beat the inflation bug, it is important that at all times investors’ ensure that their portfolios are well diversified, taking into account their needs and aspirations.

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