The writer elaborates on the effects of inflation and the best avenues for investment in such a scenario
A rupee saved is a rupee earned, inflation is inevitable, and everyone gets affected by it in every manner. Along with prices of goods, even the cost of living goes higher and so does the cost of borrowing. Inflation also has a huge impact on your investments and the way you plan it. While moderate inflation is considered good for the growing economy, high inflation is not good and it hits the worst for the poor section of the society. In the last couple of months, we have been observing a high inflation rate and have been noticing its impact on our daily lives and investments as well.
So, what is inflation?
In simple words, inflation is the increase of prices of goods and services which eventually increases the cost of living. Inflation also decreases the purchasing value of money over a period of time. Inflation erodes the pricing power and is the biggest enemy of every consumer and investor.
What has caused a high inflation now?
The high inflation that we are facing is a global phenomenon. Economist have identified several reasons from rising wages to an increase in the supply of money but the main factors are,
1. The economic crisis caused by the outbreak of the pandemic has forced Governments and central banks to take extraordinary measures in fiscal and monetary policies to deal with the chaos in the economy. These measures were expected to have an inflationary effect. The central banks were expecting the inflation to be slow and gradual, but unfortunately it was not and now the central banks are trying its best measures to control it.
2. Covid-19 pandemic and lockdowns caused a major disruption in supply chain leading to shortages in the supply side and increase in prices of commodities / manufactured products. Considering that most parts of the world have started functioning back to pre-pandemic figures, even this issue should get sorted soon.
3. OPEC countries and their partners have been cutting back on crude oil production for the last few years, leading to increase in crude oil prices. The Russian invasion of Ukraine and the economic sanctions on Russia has created an extraordinary situation leading to surge in crude prices. Since petroleum and petroleum products are raw materials in many industry sectors, this has led to very high inflation in goods and services.
What is the impact of high inflation on investments?
A high inflation is also called as negative rate of return, the real return you get from your investment is reduced due to inflation. Inflation always has a negative impact on equity related investments. Rising raw material cost does pinch the operating margins of the corporates. To curb inflation, banks increase the interest rates on fixed deposits, investors start preferring to withdraw their funds from equity and park it in fixed deposits. Inflation impacts fixed income investments the most due to its inverse relationship with interest rates. When it comes to gold, the price increases as it is an international commodity and its price is linked with our currency. (Generally high inflation results in devaluation of currency).
How and where to invest now?
While planning for your investments now, you need to consider inflation as a major factor and check whether the returns on your investment beats inflation. Inflation helps investors to understand how much returns they should make on their investment in order to have the same standard of living in the future.
So if your income doesn’t increase along with inflations then your investments need to do its magic for you. So how and where to invest?
• Asset allocation: Do not park all your investments in one asset class, for e.g. Don’t invest all your money in real estate just because you believe that the prices will rise one day and you will sell it off and reap profits. Rather, have a portfolio of mixed investment products which will give a fixed income monthly, which has the capacity to liquidate at any time, long term investments, and investments that will provide returns higher than the rate of inflation.
• Rebalance your portfolio: If your current investments are beating inflation then it is time for a revamp. Consult a professional and check the performance of your portfolio and fill the gaps to reach your desired goal.
• Goal based planning: Most people invest only when they have surplus funds and simply invest without any goal in mind, but this time when you start or realign your investments then do it as per your goals; so that you are aware on how much you need to save. Don’t change your goal but change your actions to reach that goal within the given frame of time.
If your investment strategy does not take into account the impact of inflation on investment, then expensive securities may eat into your returns.
In other words, the money that you save for the future may not be enough to beat the rising price of goods and services. But there are ways around it. As an investor, you should take a long term view and remain disciplined in your investments.