Inflation poses as a silent threat as it reduces real savings and investment returns.
Inflation impacts almost every facet of an economy, be it the cost of living, spending, business investments or tax policies and interest rates. Thus, for investors, tracking the gamut of inflation becomes imperative as it tends to impact the value of investment returns.
Back to the chalkboard- What is inflation and how does it impact investing
Inflation is a consistent rise in overall price levels. Moderately-paced inflation assists in growth as a balanced level of inflation is necessary for economic growth. High inflation indicates an overheated economy that is harmful in the long run. On the other hand, steep deflation (when price levels fall) could lead to recession and subsequently even depression.
Inflation poses as a silent threat as it reduces real savings and investment returns. The majority of investors and even laymen for that matter invest with a view to increase their long-term purchasing power and with certain goals in mind. However, inflation jeopardizes this goal because as prices move up, the value of goods that you are to purchase with the same amount of money reduces. When investment returns and rate of inflation are not in tandem, purchasing power is compromised. For example,
In order to beat inflation, identifying avenues and instruments which maximize investment returns is the key.Debt Returns or fixed income returns face a particular threat by inflation. Many Indian investors invest in fixed deposits and bonds as they represent a more secure, steady inflow, be it in the form of interest or payments. However, because the rate of interest or payment on most debt securities remains constant or only sees the slightest of changes until maturity, the return on investment falls short in meeting the inflation rate at that moment, thus reducing or nullifying purchasing power.
However, the prices of certain assets rise in parallel with an inclining inflation.
Beating down inflation
Stocks have often been a good investment relative to inflation over the long term because companies can raise prices for their products when their costs increase in an inflationary environment. Higher prices will thus translate into higher earnings.
Equity investing over a long period is the prescribed way to stay ahead of inflation. One can invest either directly in the stock market or through mutual funds. For individuals, investment via mutual funds is advisable as they may lack the expertise provided by experts in the fund houses. A diverse equity mutual fund scheme will allow you to earn higher risk-adjusted returns. Furthermore, availing of systematic investment plans or SIPs helps reduce the overall risk that comes with investing. Inflation-indexed bonds are another viable option created to protect both principal and interest. They are widely available securities in the developed markets aimed to specifically protect retail customers against inflation.
For those with larger sums to invest, assets such as real estate and gold at times can also protect against inflation. Allocating a certain section of wealth in foreign markets will allow your portfolio to withstand domestic conditions and vulnerabilities while stabilizing it at the same time.(The writer is ED and CEO of Essel Wealth Services)