Inflation is a silent thief that can slowly erode the value of your hard-earned savings. It’s a persistent rise in the general price level of goods and services in an economy over a period of time, reducing the purchasing power of money.
If you look at short term such as 6-month or 1-year data then it might be hard to notice the impact of inflation on the price of commodities. However, once you look at the long-term chart of inflation then the overwhelming evidence of the compounding effect of inflation which significantly increases the price of daily use items, becomes hard to miss.
Measuring inflation
Let’s understand how inflation is measured. The most used indicator for the measurement of inflation is the Consumer Price Index (CPI), which is the measure of the basket of goods and services such as food, clothing transportation, medical care, electricity, education, and almost everything that requires an expenditure of money.
CPI indicates the cost of living and purchasing power of consumers. As you can see from the chart below CPI almost doubled from 2011 to 2023, which, simply put, means that the cost of goods and services doubled in the same period.
If you were able to buy 4 kg sugar for Rs. 1,000 in 2011 then you will be able to buy only 2 kg sugar for Rs. 1,000 in 2023.
While inflation is a natural part of the economy, it can have a significant impact on investments, particularly if not taken into account while making investment decisions.
In this article, we’ll delve into the impact of inflation on investments and provide a comprehensive guide on how to protect your investments against their effects. Whether you’re a seasoned investor or just starting out, it’s important to understand the impact of inflation on your wealth and how to stay ahead of it.
Invest in Assets that Appreciate Faster than Inflation
One of the most effective ways to counteract the consequence of inflation on investments is to invest in asset classes that can grow faster than inflation. For example, investing in stocks, mutual funds, and real estate can be a good idea to protect against inflation. These investments have the potential to increase in value over time, and their returns can help to offset the impact of inflation. Historical data proves that over the long term stock market, mutual funds and real estate have given returns to investors well over the rate of inflation.
Mutual funds
Consider investing in mutual funds that have a strong track record of steady growth and profitability. These funds are more likely to weather economic storms and maintain their value, even during times of high inflation. You can refer to this guide for the selection of mutual funds.
Direct equity Investment
Stocks have not only given handsome returns to investors and helped them stay ahead of inflation but also helped them create massive wealth. But of course, there is an inherent risk in direct stock investments. You must understand the business and fundamentals of the company. You must be able to read the financial statements, which the company releases quarterly and yearly. Hard work and diligence are a must for direct stock investment, if you choose to invest based on tips in hope of quick gains, you are much more likely to run into losses.
Real estate investment
The American satirist and author Mark Twain once famously said “Buy land, they’re not making it anymore”.
Real estate is an investment that can help to counteract the impact of inflation. As inflation increases, so does the value of the real estate, providing a hedge against the eroding value of money. Whether you invest in rental properties or flip houses, real estate can be a valuable addition to your investment portfolio.
Real estate is a tangible and illiquid investment. If you prefer liquid investment you can use real estate investment trusts (REITs), which can be traded more easily in the market. It is an investment vehicle which invests in income-generating real estate properties such as apartments, offices, shopping centres, hotels, etc. It lets people own real estate without actually owning a piece of land and saves them from the hassle of finding tenants, doing repairs, collecting rent, etc.
REITs are traded like ETFs on stock market exchanges. You can buy units from the stock market. Thus a demat account is a must for investing in REITs.
Commodities such as Gold and Silver
In addition to investing in stocks, mutual funds and REITs, individuals can also consider investing in commodities such as gold and silver. These commodities have historically been considered safe-haven investments and have held their value well during times of high inflation. According to financial experts, 10-15% of your portfolio should be allocated towards gold. But, how to invest in gold? Let’s look at some ways in which you can invest in gold:
- Physical gold
You can choose to buy physical gold, but this method is not advisable because it involves high making charges, storage costs, impurities and risk of theft.
- Electronic Gold or E-Gold
E-Gold is an investment prospect that allows buying and selling of electronic gold through stock exchanges, similar to shares. In order to participate in trading E-Gold, it is mandatory to have a demat account. Each unit of E-Gold is equivalent to one gram of physical gold.
- Sovereign Gold Bonds (SGBs)
SGBs are governent backed gold bonds. SGBs also provide a guaranteed interest rate, it regularly yields 2.5% on the investment amount. These returns are paid semi-annually. However, SGBs have a lock-in period of eight years (But there is an option to redeem them after completing five years) and are comparatively less liquid than gold ETFs or gold BeEs.
- Gold BeES
Returns given by Gold BeES are closest to that of physical gold. It invests in the finest gold of purity 99.5%. Gold BeES can be traded like ETFs on stock exchanges hence they are the most liquid investment option.
If you sell Gold BeES holding before 36 months then STCG as per your tax slab will be applicable. If you sell Gold BeES holding after 36 months then 20 % LTCG after indexation will be applicable. As opposed to buying or investing in other forms of gold, gold ETFs do not attract wealth tax, GST, or STT.
Summary
It’s important to remember that no single investment is a surefire solution to the impact of inflation. The best way to protect against inflation is to create a diversified investment portfolio that includes a mix of different types of investments such as mutual funds, stock investments, REITs and Gold BeES.