Expert advice

Oct 31, 2012,18.08 IST

Inflation worries: What can you do about it

Albert Einstein had remarked – “Compounding is the eighth wonder of the world”. And so it is. The cumulative effect on one’s savings is simply amazing. The money value does increase in rupee terms. But then, does the value of the rupee in future stay the same as that of the rupee invested?  Putting it another way, does the rupee retain the same purchasing power in future as that of the rupee being invested. That is a moot point.

We are a country of savers but want to save without risk. We clamour for fixed, but  good interest rates.  Many times the interest rates seem good on the surface. But what one notices is the pre-tax rates. Post-tax, the rates are not so attractive. For instance, a 9.5% pre-tax rate translates to a 6.6% post-tax return for someone in the highest tax bracket. It does not look that good after all.  

The story does not end there. There is a spoilt-sport called Inflation here, who will further wield the chopper. The effect of inflation is acknowledged; but it’s deleterious effect is not fully understood.  Inflation is the silent killer which we don’t acknowledge as such.

Inflation number we hear is pure fiction – for the man on the street, 7.5% inflation figure is a joke. The common man is experiencing double-digit inflation in many areas of his life. Food inflation is probably the most troubling. It probably is anywhere between 15-20%. Prices of most food items have doubled in the last three years. Vegetables which used to have seasonal variations, are stubbornly stuck at Rs.40+/kg levels.

The inflation in fuel is probably around that figure too. Auto Rickshaws & taxis hiked their rates by around 25% recently. It’s cruel to say electronics prices have come down over time. After all, how many TVs or cameras do we buy in a year? Including a bunch of items in a common WPI & CPI brings down the number – but that does not help the man on the street who is battered by double digit inflation in food & fuel.

In this situation, the money is losing value fast. Saving in instruments which offer 7% returns is not good enough. What can investors do about it?

Invest in growth assets: To beat inflation, invest in growth assets. This is a well-worn advice – but there isn’t anything else. Assets like Equity ( including Equity schemes of Mutual Funds ), Property are growth assets. Investing in them will ensure that one can make money grow in real terms. But, even that happens over time. In the short-term Equities are prone to volatility and can shake the faith of people ( like it is doing now ). Gold has been performing very well in the past 10 years.  A small allocation ( say 5% of the portfolio ) here can be good too. Get this right and you would be able to be ahead of inflation, atleast in the longterm.

Look for investments where taxes are minimal: When taxation is minimal, the returns are better hence offering good post-tax income helping to combat inflation better.  Investing in PPF /EPF is a good idea due to the tax exemption they enjoy at investment, accumulation and disbursement (EEE treatment). Even this may not beat true inflation that one is facing; but it would be vastly better as compared to say FDs, where interest is fully taxable. Debt MFs are a good bet too. Investments over one-year in debt MFs come under capital gain tax treatment. Here, the taxes are 10% without indexation and 20% with indexation. Indexation takes into account inflation ( government published figures, though ) and that makes matters a bit better. The effective tax after indexation may be 5% or less, for a one year plus period. Also, tax free bonds ( which was issued for 8.2-8.3% coupon rate ) are good too. Only for those in the lower income tax brackets, bank and company FDs may be good options.

Make your existing assets sweat: Many investors do not manage their money well. In many cases, we have found huge amounts of money lying around in SB accounts which yield 4% interest. Now, this income is also taxable… for those in the highest bracket, the yield is a mere 2.8%!  Many are locked into low yielding FDs ( which was done a while ago and was never reviewed ) & Investment oriented insurance policies ( which yield 6% or less ). This results in a very poor return from a portion of the portfolio and hence negative real returns. Regular review of the portfolio is a must to correct these problems. Again, this is something many investors don’t do.

“Inflation is when you pay fifteen dollars for a ten dollar haircut, you used to get for five dollars when you had hair”, goes a wise crack. Inflation is something we do not have any control over. RBI has been trying to tame it, without much success. 

Inflation is a systemic risk, which cannot be diversified. So we need to live with it, after taking measures we can. But haircut inflation rankles the most – we may not have too much hair left, thanks to inflation worries… but still, they charge the same amount for a haircut making it exponentially costly per strand of hair tackled!

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