Protecting your investment from inflation: A Strategic Approach
Many investors are concerned that the effect of inflation can be a huge obstacle to building wealth. While it is impossible to eliminate inflation, you can mitigate the impact of inflation by using a few techniques to safeguard your financial objective; it's essential to understand how inflation subtly but significantly influences both everyday expenses and long-term investments.
What is Inflation?
Inflation can be called a “Silent Wealth Eroder” because it gradually diminishes purchasing power. Inflation refers to the rate at which the general level of prices for goods and services in an economy rises over time. As inflation increases, the purchasing power of an individual decreases with the same amount of money, meaning one can buy fewer goods or services with the same amount of money.
Let's examine the impact of inflation based on the recent RBI report dated March 31st,2024, which reveals that the average inflation has increased by 5.64% over the past 30 years.
|
Years |
Gold |
Petrol |
Diesel |
Milk |
|
1990 |
3,200/- |
9.84/- |
4.08/- |
6/- |
|
2005 |
6,145/- |
38/- |
28.22/- |
19/- |
|
2024 |
67,252/- |
96.50/- |
92.15/- |
74/- |
|
Actual Inflation |
9.36% |
6.94% |
9.59% |
7.66% |
Source:- Gold Rate Per 10 gram - RBI website, Petrol & Diesel Rate are taken for Surat City & Milk Price is taken from Big Basket App for Per Liter as of 31st Mar 2024. Inflation data before 2012-13 is taken as per WPI rate & from 2012-13 CPI rate is considered - RBI
Inflation may seem insignificant when dealing with small expenses, but its impact becomes much more apparent when it comes to larger investments. As seen in the comparison of prices over the years for items like gold, petrol, diesel, and milk, inflation erodes the purchasing power of money over time. For example, while the price of gold has increased from ₹3,200 in 1990 to ₹67,252 in 2024, inflation at an average rate of 9.36% has caused the value of money to decrease significantly. This means that the same amount of money will buy less in the future, impacting savings and investments.
For investors, inflation can hinder the growth momentum of their wealth. If your investments don't earn a return that outpaces inflation, the real value of your money decreases over time. This is why it's crucial to consider inflation when planning for long-term financial needs.
How to check your investments are protected from inflation?
Inflation gradually diminishes your money's purchasing power. To ensure your investments are safeguarded against its impact, it’s important to evaluate the real returns on your portfolio and adopt strategies that help combat inflation effectively.
Here’s how you can check if your investments are protected against inflation:
Understand Real Returns
- Real Return Formula: Real Return = Nominal Return − Inflation Rate
After adjusting for inflation, if your investment generates a negative real return, your money's value is eroding.
- Example: Say you invested in a bank FD @7%. The bank FD interest is taxable as per your income tax slab, let us assume that at 20%.
You will earn a post-tax return of 5.6%. If we assume inflation of 6% in that period, your investment will earn a negative return of -0.4%. A negative real return indicates that your investment is failing to protect your wealth from inflation.
Let’s explore how to combat inflation and safeguard your financial future.
- Invest wisely: The first step to beat inflation is to invest wisely and make smart investment choices. One of the best ways to do that is through equity mutual funds. Equity Mutual funds help you grow your money by investing in a diverse range of stocks, giving you the potential to earn more than inflation. Historically, equity as an asset class has outperformed various other asset classes by a huge margin. In the last 45 years, on average, inflation was around 7%. Sensex has delivered a whopping real return of 8.25% in that period. So, equity has helped investors to build wealth in the long run.
Source: RBI - Inflation data as on Mar 2024 (Note: Inflation data before 2012-13 is taken as per WPI rate & from 2012-13 CPI rate is considered.) || Source: RBI - Gold & Silver data as on Feb 2024 || Source: RBI - Bank Deposits & Co. Deposits data as on Sep 2023 || Sensex data as on Mar 2024 - Source BSE
- Cut down unnecessary expenses: The best way to protect your wealth from inflation is by reducing non-essential spending. By doing so, you can free up more funds to invest in inflation-beating opportunities like mutual funds and real estate. As you consciously control your expenses, you can ensure that your money works harder for you. This approach will help you stay ahead in the financial journey while prioritizing your long-term financial needs, financial security and building wealth.
- Diversify your investments: Diversification is key to managing the risks that come with inflation. By spreading your investments across different asset classes, you reduce the likelihood of being negatively impacted by the poor performance of any single investment. This strategy ensures that, even if one asset class struggles, the others may continue to grow, helping protect your wealth from inflation. It’s not about choosing individual options, but rather creating a balanced portfolio that can tackle different economic conditions. A well-diversified portfolio offers greater stability, boosts your chances of achieving consistent returns, and helps your wealth grow over time, outpacing inflation.
Conclusion
While inflation is inevitable, it doesn’t have to derail your financial aspirations. Using a few techniques of investing such as diversification, disciplined investing through SIPs, and a focus on long-term growth and seeking guidance from mutual fund distributors can help investors not only preserve their wealth but also achieve financial growth that beats inflation.
Start early, stay consistent, and let mutual funds work as your shield against inflation—ensuring a secure and prosperous financial future.
Mutual fund investments are subject to market risks. Please read all scheme-related documents carefully before investing.