Beating inflation is key. Why do you invest? Invariably, it is for the future.
If one didn't fear the uncertainty of the future, then no-one would dream of doing things. Dreams of building a house, driving a fancy car would simply not exist. People would just want to live in the moment. One would not be worrying about what happens in the future.
However, such an attitude might not be considered healthy. Because sooner or later there's going to be a time when you won't be able to earn more money. You will reach retirement and not have a steady income to rely on.
If you know that you are not going to generate a steady income at some point in the future, the smart thing to do would be to ensure that whatever you save and invest today increases in value as time passes.
The inflation rate is that unexpected factor that slowly creeps up on you when you least expect it.
Once you decide to invest your hard-earned money, don't forget to account for inflation. A portfolio that is inflation-proof ensures that when you are ready to take the returns, your money still has value in the market conditions prevailing at that time in the not-so-distant future.
Simply defined, inflation is when once you were able to purchase X number of goods, thanks to the rise in prices, now you can only buy a fraction of the products that you were initially able to purchase from the same amount of money.
Inflation becomes a troublesome concept when you start comparing your salary with the rising prices. That’s when you realize that your salary doesn’t increase at the same pace as the prices. Average inflation in India is usually at 10-11%. For your investment to beat inflation, the returns that you get from your investments should be more than the inflation rate.
Here are a few ways in which you can insulate yourself from feeling the pinch of rising inflation rates:
Investing in the right equities
Trading in commodities can work--given that prices of consumer goods rise during inflation. Investing in consumer goods is not without risk and hence, should be carefully monitored.
Beating inflation is essential to ensuring that you are capable of living the lifestyle that you enjoy even when you are not working. Only saving your income won’t achieve that. Because the Rs. 1 lakh that you can spend today is going to get you fewer goods and services 10 years from now.
Invest in dividend-paying equities
Investing in high-dividend yielding equities helps catch up to the inflation rate. The securities that are high dividend paying are likely to increase the amount of dividend that they pay to their shareholders over a period of time.
Dividends vary depending on the companies that you invest in. This is where your research is going to play a vital role. Identifying equities that are relatively stable and give you a high dividend helps in preparing for impending inflation.
This form of beating inflation is crucial not only for the veteran investor but also for the one just starting out. For a young investor who has many years before she/he reaches retirement age, the inflation rate can keep building up and the value of investments cannot keep up. Thus, the earning power is of no use in this case if your investments can’t beat upcoming inflation.
Not relying solely on Fixed Deposits
Creating an FD might seem like the most natural thing to do once you decide to take control of your finances and take steps to become financially secure.
Fixed Deposits, however, are not necessarily the best way to grow your money. You might as well store them away like your grandmother did--hide the money in a pot of rice. Because by the time that FD matures, the returns that you get are of lesser value than they were a few years ago--thanks to a high inflation rate.
For example, if you invest Rs. 1 lakh in an FD with a rate of interest of 8.25%. After taxation, the rate of return lowers to 7.42% if you are in the 10% tax bracket. Considering that the average inflation rate 10%, your rate of return is almost 3% lower! That basically means that when your FD matures and you get your returns, the amount in your hand has reduced in its value.
National economic decisions impact interest rates that the banks can provide to its clients. During times of fluctuating interest rates, the new FDs that you create are likely to yield you a much lower return than usual.
However, when the interest rates are favorable, purchasing FDs of short-term maturity could be one way to invest in an extremely low-risk option.
Investing in Debt Fund
A debt fund falls under the long-term capital gains category. Investing in a debt fund is different from waiting for an FD to mature. A major difference is that investing in a debt fund affords the investor the benefit of indexation. Indexation is the process of calculating the Cost of Inflation at the time of taxing a debt fund.
For example, you invest Rs. 1 lakh in a debt fund with Rs. 10,000 interest every year. At the end of a three-year period, you’ll get a return of Rs. 28,452.66 considering that you are in the 30% tax bracket. The average rate of return, in this case, is 9.48% that is almost equal to the rate of inflation.
A debt fund like the one considered in this example has been invested for a period of more than three years and is a long-term capital asset. The total return that you thus get on your Rs. 1 lakh is Rs. 128,452.66.
Re-evaluating and Reassessing Portfolio
Some investors and traders might conduct a lot of research at one point in time and purchase a variety of assets. However, in the next 5 years, 10 years, they might not pay attention to their existing portfolio trusting that they are bound to make some profits from their investments. Even if your trading and investing strategy is bearish, it doesn’t mean that you forget to reevaluate your existing portfolio.
During times of volatility and fluctuations in the markets, it is important to look at the market forces and how they impact your portfolio. Even if you don’t react or give in to the prevailing frenzy of other market participants, it is vital that you pay attention. Sometimes, reassessing your portfolio and making the required changes can yield you better returns and set you up for success in the long-run.
These are just some ways in which you can tailor your investment and trading strategy to beat inflation. However, there’s no full-proof plan which guarantees complete victory over rising inflation.
Inflation is inevitable. Smart investors prepare for the inevitable.