Inflation and Its Impact On Investments

A penny saved is a penny earned. But thanks to inflation, over time, the value of the penny saved could be much less than when it was earned. One cannot ignore the corrosive impact of rising prices on investments. Understanding inflation is crucial to investing because inflation can reduce the value of investment returns. Inflation affects all aspects of the economy, from consumer spending, business investment and employment rates to government programs, tax policies, and interest rates.

WHAT IS INFLATION?

Inflation is a sustained rise in overall price levels. Moderate inflation is associated with economic growth, while high inflation can signal an overheated economy.

HOW DOES INFLATION AFFECT INVESTMENT RETURNS?  

Inflation poses a “stealth” threat to investors because it chips away at real savings and investment returns. Most investors aim to increase their long-term purchasing power. Inflation puts this goal at risk because investment returns must first keep up with the rate of inflation in order to increase real purchasing power.

If investors do not protect their portfolios, inflation can be harmful to fixed income returns, in particular. Many investors buy fixed income securities because they want a stable income stream, which comes in the form of interest, or coupon, payments. However, because the rate of interest, or coupon, on most fixed income securities remains the same until maturity, the purchasing power of the interest payments declines as inflation rises.

Equity Mutual Fund

Let’s look at some ways to stay ahead of inflation :

• Invest In Equities/Equity Mutual Fund:
  Investing in equities over a long period is one of the best ways to stay ahead of inflation. Over the last 10 years, the Nifty has returned 16.7% a year compared to the 7% average inflation rate. One can either invest directly or through mutual funds. For small investors, it is advisable to invest through mutual funds, as they are managed by experts.Investors should look at diversified equity mutual fund schemes to earn higher risk-adjusted returns. However, equity investments should have a horizon of at least Three years, sometimes even longer.
• Another way of lowering the overall risk is investing via systematic investment plans or SIPs. The compounding impact of such investments over long periods will help you beat inflation by a comfortable margin.

• Invest In Dividend-Paying Stocks:
  One good way of staying ahead of inflation is buying stocks that pay good dividends. The interest rate offered by banks is usually much less than the inflation rate. Just like inflation, dividends, too, can be calculated annually. This figure, called the dividend yield, can be measured by adding dividends received during the year and dividing it by the stock price. The yield must be higher than the annual inflation rate.

• Diversification:
  Asset allocation is critical. In this, one can look at an opportunity is to diversify globally. This will make your portfolio more stable and less vulnerable to domestic volatility and inflation.

CONCLUSION

A general inflation rate is published every year by the government but that is based on some daily use items and control materials. The fact is that every one of us has a different set of the inflation rate. Just take a look at how much you are spending every year and you will most likely find that your expenses keep increasing at a much higher rate, regardless of the official rate.

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