This article will help you understand “Inflation” and “How to beat it”
1. What is inflation?
- Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increases as inflation rises; every rupee you own buys a smaller percentage of a good or service.
- Inflation is an economic monster, which spares none. Individuals, companies as well as government are affected by rising inflation.
- A low acceptable level of inflation is required for any growing economy; however a high level of inflation is destructive for the entire economy.
- In India, the average CPI(consumer price index) OR Retail inflation has been close to 8% per annum, if one takes a long term average of last 54 years (from 1961 to 2015)
2. How does inflation affect our daily life as well as investments?
- Inflation ensures that the prices of all our daily items of purchase such as food, fuel, manufactured items, and services start increasing and hence our monthly expense budget also increases as we spend more money to buy the same quantity of goods or services. As a result, the disposable income (income left over after expenses) starts to decrease.
- Due to this, the amount available to invest the surplus also decreases. This leads to a longer time to achieve our financial goals
- Investments like fixed income / debt / fixed deposits are most affected by inflation as rising inflation leads to rising interest rates, which in turn reduces the prices of bonds and fixed income instruments.
3. How does one beat inflation?
- Investing in equity stocks and equity mutual funds through a staggered approach (SIP) is the best way to beat inflation. In the long term (15 to 30 years) the equity market indices (NSE nifty and BSE Sensex) have given an average of 15% to 16% p.a. annualized returns, which is far better than the average 7% to 8% annual inflation rate in India
- Invest in high dividend yield stocks
- Invest in gold and real estate: Gold is a natural hedge against inflation. Real estate though quite expensive is another option. Only a small portfolio should be invested in Gold.(ideally always less than 10% of your total portfolio)
- Invest in inflation-indexed bonds: the principal amount is indexed to inflation. These bonds are issued by RBI.
- Diversify geographically: This will make your investment portfolio less vulnerable to domestic inflation. Mutual fund schemes are available which invest in U.S. equities and these can be used to diversify your country risk.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.