The after-effects of all the easy money provided by central banks around the world to combat the COVID-19 slowdown are showing up through inflation. Inflation reduces purchasing power, or the ability to purchase goods and services. Rising inflation raises the cost of living, but the return on investment does not follow suit. Retail inflation in India increased to 6.3% in May 2021, up from 4.23% in April 2021. However, in August, it fell to 5.78%.
What Does ‘Beating Inflation’ Mean?
Beating inflation implies earning higher returns on investment than the economy’s inflation rate. If the increase in prices of goods and services exceeds the returns you earn on investments, your returns are null and void.
Assume you invested Rs 1,000 in an investment that returned 4% the following year. Your investment is now worth Rs 1,040. On the other hand, the economy’s inflation rate is 5.5%. Your return on investment is less than the inflation rate, effectively cancelling out the returns you earned.
Every year, the purchasing power of money decreases significantly for different reasons. As a result, prices of goods and services rise. This economic phenomenon is described as inflation.
How to Beat Inflation In India?
Investing in instruments that have a higher chance of being equal to or greater than the rate of inflation tomorrow is one of the best ways to beat inflation. Investors should always conduct thorough research on their risk profile and goals when selecting the best investment instruments for beating inflation.
It may become difficult to assess your risk profile and financial goals. Obtaining financial advice from a Registered Investment Advisor can assist you in risk appetite and financial goal setting. If you don’t want to go the traditional route, modern new-age advisors like Tavaga can help. Tavaga assists you in achieving your financial objectives at a reasonable cost by providing tailored guidance and portfolio performance.
Diversification is one of the important steps to remember during investments. A few investments, particularly equity-oriented investments, may appear to provide extremely high returns, but they also carry some level of risk. It is important to diversify following your objectives, risk tolerance, and inflation expectations.
Let’s look at some investment options in India and see if they’ve been able to outperform inflation in the past. It is also important to remember that past performance is not always indicative of future performance.
1-Direct investment in the Stock Market
In general, stock returns outperform inflation rates. Considering the rising prices of goods and services can mean higher profits for businesses. Better prices lead to higher share prices. However, there may be times when this is not the case, but in the long run, the stock market has historically provided returns that outperform inflation.
Stock markets have outperformed inflation in the long run but there are many ups and downs and volatile situations, in the short term. One of the apt examples can be the years 2020 and 2021. The Sensex had reached 25,000 in March 2020, down from around 40,000 in January 2020. By 2021, Sensex has surpassed 56,000 points.
Over the last five years, Sensex has returned more than 88% CAGR as of April 2021. However, Individual stock performance may differ from benchmark index performance.
This demonstrates that the markets recover in the long run. Risks and losses balance each other out. Stock market investments that are goal-oriented and well-researched can help you beat inflation.
2-Equity Mutual Funds
Monitoring the movement of individual stocks or the market daily is a difficult task for many investors. They can invest in equity mutual funds after determining which fund appears to be best suited to their specific needs and expectations. There are various subcategories of equity funds that can meet the needs of various types of investors. There are market capitalization-based equity funds, sectoral funds, equity funds based on investment strategies, tax-saving funds, and more.
Most equity funds’ 5- and 10-year returns have remained consistently above 10%.
3-Exchange-Traded Funds (ETFs)
ETFs are a type of mutual fund that tracks broader market indices such as the Nifty or Nasdaq. ETFs are more diversified and have lower expense ratios of less than 0.5%. The broad market indices are composed of large-cap firms that grow faster than the economy and thus provide returns greater than the inflation rate. ETFs are relatively new in India, but in the United States, ETFs account for a sizable portion of the S&P index. ETFs can be relied on to deliver substantial gains and outperform inflation in the medium to long term.
Indians have traditionally invested in gold because it does not require them to be market savvy. People regard gold as a safe bet against the cyclical volatility of stock markets. It is regarded as a good inflation hedge because increases in its prices and returns have been able to offset inflation. The demand for gold increases when inflation increases.
Gold is a commodity, not a financial asset. According to a World Gold Council study, for every 1% increase in inflation, there is a 2.6% increase in gold demand, and an increase in demand leads to an increase in price.
Gold Exchange Traded Funds (Gold ETFs)
Gold ETFs are open-ended mutual fund schemes that provide investors with exposure to the gold market and are based on the ever-changing price of gold. Physical gold does not generate income and the making charges on physical gold are high. Gold ETFs are an excellent long-term investment option for investors seeking to outperform inflation.
Real estate investments have managed to outperform inflation in India, but they require a significant amount of capital, often in lakhs or crores. In most cases, investors must account for the interest they pay on loans used to purchase a home. The value of the real estate is highly dependent on the geography of the area due to which it frequently yields a higher return than inflation.
According to the RBI’s House Price Index, which collects real estate prices in ten cities, the average return on real estate ownership over the last ten years has been around 11.6 % (as of Oct 2020). This is the average return for the entire country. In reality, returns may differ from city to city due to the geographic variation in property prices.
Real estate investment trusts (REITs)
Investors who find it difficult to opt for real estate due to huge capital requirements can opt for REITs. REITs are corporations that own and/or operate properties such as apartment complexes, office buildings, shopping malls, and warehouses. They are a pool of real estate that pays out dividends to its investors.
When inflation rises, so do property prices and rental income. REITs perform well during inflationary periods because of their ability to raise rents and then pass that income on to shareholders.
REITs also have some disadvantages, their sensitivity to demand for other high-yield assets. Treasury securities generally become more appealing as interest rates rise This can draw funds away from REITs, lowering their share prices. Property taxes must also be paid by REITs which is an added expense.
Bonds or debt funds that invest in bonds are closely linked to the economy’s interest rates, which work in conjunction with inflation rates. Interest rates rise when inflation rises. Interest rates and bond prices move in different directions. As a result, bond prices will fall when the interest rates increase. Inflationary environments can cause bond funds to lose value. Diversification is very important for managing returns, capital preservation and inflation-adjusted returns.
1-Investing in Inflation-Indexed bonds
Inflation-indexed bonds are one of the most secure and effective ways to protect against inflation. Inflation-indexed bonds are one of several types of bonds issued by the government through the RBI. This bond is unique in a way that it adjusts its principal amount to account for changes in inflation, and interest is paid on the adjusted principal.
The calculation is a little complicated, but let’s look at an example to help you understand it. Assume that the inflation rate at the end of the year is 10%. You own a Rs. 100 bond that pays an annual interest rate of 8%. In the case of a normal bond, the interest at the end of the year would be Rs.8, but in the case of an inflation-indexed bond, the principal would be adjusted to inflation, meaning it would now be Rs.110, and 8% would be paid on this, Rs. 8.8.
2-Debt Mutual Funds
Debt mutual funds are investment vehicles that invest in individual bonds. These are highly liquid investments that also pay a fixed rate of interest. The interest rate is set to account for changes in inflation. As a result, it is a viable option for beating inflation. Debt funds are divided into more than ten subcategories, and over the last 5-10 years, most subcategories of debt mutual funds have returned between 7% and 10%. However, the risk-return potential of each subcategory varies. The use of debt-based investments to hedge against inflation is determined not only by returns but also by your risk tolerance and goals.
Some tangible assets, such as vintage cars and fine art, can act as an inflation hedge. It is expected that the prices and value of these collectibles will rise over time, providing returns that exceed the rate of inflation. However, they are highly volatile, and there will be trust issues with these assets. Also, investments in hedge funds or start-ups through unlisted shares can help in beating the inflations. But these have to be considered only based on your risk profile and investment goals.
Rebalance Your Portfolio
Rebalancing your portfolio entails rearranging the assets in your portfolio in response to long-term market conditions. Volatile changes in inflation rates, a shift in financial objectives, and a variety of other factors may necessitate portfolio rebalancing. A portfolio built-in 2012 with the economy and inflation rates in mind may not work for you in 2021. As a result, revisiting your portfolio and making changes only when necessary is an important component of hedging your portfolio against inflation.
Inflation is a long-term socioeconomic phenomenon that has a cascading effect on individuals. To beat inflation, various market strategies have evolved. Inflation is primarily caused by cost-push or demand-pull situations. It is completely possible to outperform inflation, but it is also necessary to realign the portfolio regularly to readjust to current inflation levels.