Taming The Inflation Monster
Inflation is the hidden enemy that eats into your savings and plays havoc with your financial goals. Here is how to invest smartly and secure your future
Those in their twenties would have heard their elders saying that while Rs 500 bought you a lot of groceries 20 years ago, it hardly gets anything now. The reason for that is simple -- inflation.
Inflation is a silent tax that reduces the value of money over time. For the same reason it wrecks your savings as well. To put it simply, if the returns you are getting by saving or investing your money is the same as the inflation rate, then your money grows notionally only over time, and Rs 100 you invest today will be worth about Rs 100 only in 10 years. If the rate of returns from your investment is lower than the inflation, your money may grow over time, but then Rs 100 you invest today will buy you goods worth less than Rs 100 ten years from now.
What is worse, inflation is a hidden enemy and it attacks you in ways you do not understand until it is too late. In fact, inflation does not attack obviously with its tentacles like Kraken, the legendary sea monster, but slowly and surely eats away into your savings like the rare brain eating amoeba that kills brain tissue and leads to death.
Not surprisingly, Margaret Thatcher, the former British Prime Minister once referred to inflation as the “unseen robber of those who have saved”.
This brings us to the common monkey and pole maths problem. There was a monkey and a 30-metre pole which was oiled. Every time the monkey climbed two metres on the pole, in two minutes it slipped 1.8 metres.
Here two metres is the growth of your portfolio and 1.8 metres is inflation. When the monkey is climbing two metres in one minute, it is actually ending up climbing 200 metres. At this rate, the monkey will still reach the top, but it will take a lot longer than the 15 minutes it would have actually taken if it was not slipping every time. This is what inflation does to your savings.
When factoring in inflation, one should not go with headline inflation numbers, like the consumer price index (CPI) which does help decide Reserve Bank of India’s (RBIs) monetary policy, but is not very helpful to the common man. “The point to note is that the real inflation which impacts our lifestyle like white goods, medical, travel, education, etc. is much higher,” says Mayank Bhatnagar, Co-founder and COO, FinEdge, a digital wealth management platform.
The Risk of Fixed Income
Indians love fixed deposits (FDs). And why not? After all, they provide guaranteed returns, unlike the markets which go up and down over a short period of time and may even give negative returns. RBI data shows that about Rs 10.27 trillion was locked in bank deposits in fiscal year 2023. To provide context, only about Rs 1.8 trillion of household savings went into mutual funds through systematic investment plans (SIP) in the same year. While one may invest in FDs, investing only in FDs will mean that one’s investment fails to face, let alone beat the inflation monster.
“This is caused by people not understanding the difference between nominal returns (for example, FDs pay seven per cent pre-tax interest) and real returns (after subtracting six per cent inflation, FDs pay one per cent pre-tax interest). Applying a 30 per cent tax rate, the nominal returns on FDs drops to 4.9 per cent and after subtracting six per cent inflation, the real returns are negative 1.1 per cent,” says AvinashLuthria, SEBI registered investment advisor (RIA), Fiduciaries.in, an investment management firm.
Agrees Adhil Shetty, CEO, BankBazaar.com, a fintech portal: “In periods of high inflation, the real return on FDs ends up being negative, as the interest earned may not keep pace with the rising cost of living. This means that while your nominal capital is protected, its purchasing power diminishes over time. In other words, the real value of your investment decreases.”
So, if you are planning to create wealth to meet any future goal that is five or more years away, investing just in FDs can bring about your financial doom. Unless your income goes up drastically or someone leaves you an unexpected inheritance, you will be in trouble.
You can also be making an equally bad mistake if you invest in other products which promise guaranteed returns. “Investment products with guaranteed returns typically end up giving sub-par returns. For example, endowment insurance products are high cost, low liquidity, and could fetch a return of less than six per cent. This makes insurance completely avoidable as an investment product,” says Bhatnagar. In fact, experts suggest never to mix investments and insurance.
The Power of Equity
Now that we have established that inflation is a monster, and that investing in FDs do not help beat inflation, in the true essence of a good versus evil saga, we need a superhero to come and save you from the evil monster. If you are a Batman fan, you may think of Batman being there to save Gotham city, if you are an Avengers fan, think of Iron Man saving the universe from decimation. And if you are a devotee of Lord Rama, think of him defeating Ravana and his army of demons.
In your fight against inflation, your superhero is equities. While equities may be volatile over a short period, over a longer period it is unanimously the best bet to fight against inflation and come out victorious.
“The only asset class which has consistently given returns in excess of 15 per cent and has outpaced inflation by a decent margin over a 10/15/20-year horizon would be equities,” says Bhatnagar.
How are inflation and equities connected? Anand Varadarajan, Business Head, Institutional clients, Banking, Alternate investments and Product Strategy, Tata Asset Management, explains.
The nominal gross domestic product (GDP) has two components. One is the real growth, which is the actual GDP growth number, and the other one is inflation. So if you have five per cent inflation and seven per cent real GDP growth, nominal GDP growth will be 12 per cent.
“If you look at markets, or any company, for that matter, typically they will tend to grow a little better than nominal GDP. So some companies will do better and some companies will do worse. And on an average, the index will give you some outperformance over nominal GDP. The index, if you were to look at it over the long term, does at least a couple of percentage points more than your nominal GDP growth,” says Varadarajan.
SIPs the Way to Go
Investing in direct stocks is one way of investing in equities. But it requires a lot of expert knowledge and time, and all of us may not be equipped to invest into stocks directly. The other way to invest in equity is through mutual funds.
Taking the example of Lord Rama, we know his most powerful tool was his Vanara Sena, which eventually helped him to win his war against Ravana. In your fight against inflation, your most powerful tool is mutual funds.
“As far as mutual funds are concerned it is the equivalent of a thali. If you were to go and buy stocks of Infosys, HDFC and so on they would be expensive. And if you have Rs 5,000 to invest, you will at best get some four or five stocks and your portfolio is over,” says Varadarajan.
However, when it comes to mutual funds, with as little as Rs 500 you can buy into several stocks. So, it is like à la carte versus thali. In à la carte food may get wasted and you can try one or two or three dishes at best. But like a thali which lets you taste almost everything the restaurant has to offer in small quantities, a mutual fund lets you invest across indices, sectors, and themes.
“Primarily, equity mutual funds offer an opportunity to take exposure across various market capitalisations such as large, mid, and small caps. They also invest across various sectors based on the valuation and earnings potential, which helps in diversification and tends to provide higher return opportunity,” says Sirshendu Basu, Head - Products, Bandhan Asset Management Company (AMC).
And the best way to invest in mutual funds are SIPs. “SIP is the simplest and proven approach to beat inflation and volatility in the long term. Theoretically, a modest inflation is generally good for equity investment because a decent inflation tends to bring positive economic growth, rising corporate profits, and stock price,” says Prashanth Tapse, Senior VP (Research), Mehta Equities, a brokerage firm.
The Magic of Diversification
This is not to say that one should invest all their money into equities. When investing, diversification is crucial. Even within equities, diversification is important and it goes beyond spreading your investments across investing in large, mid and small caps.
Also, by spreading one’s investments across different sectors, one can potentially optimise returns in the long term. “This is because sectors, such as healthcare, technology, infrastructure, etc. behave differently in various market conditions with sector rotation opportunity,” says Basu.
Also, the principle of diversification is based on the principle of investing in uncorrelated assets which helps investors reduce their exposure to risk that we associate with a certain asset class. “Diversification of the portfolio minimises risk as the portfolio constituents have lower correlation,’ says Amar Deo Singh, Senior VP, Research, Angel One, a brokerage firm.
There are certain mutual funds which help you get exposure to different asset classes like equity, debt and gold by investing in a single mutual fund. “Multi asset allocation funds diversify across asset classes with low correlation and are better placed to give a less volatile ride to the investors over the medium to long term. Multi asset allocation funds can also look at dynamically moving across asset classes to benefit from the volatility in different asset classes,” says Devender Singhal, Executive Vice President and Fund Manager, Kotak Mutual Fund.
The Real Deal
Historically, real estate has served as a hedge against inflation because it tends to appreciate in value over time. In times of inflation, when the prices of goods and services rise, real estate prices also typically increase. This phenomenon helps real estate owners maintain their purchasing power.
Between 2016 and 2020, there were periods when the supply of real estate exceeded demand, resulting in stable price growth that kept pace with inflation. However, following the pandemic, the recovery in residential real estate has been rapid, leading to significant price growth rates that have outpaced general inflation.
“This has helped mitigate the risk of inflation for property owners and investors alike. During the last two years, residential real estate prices have appreciated at a CAGR of 13 per cent whereas CPI inflation moderated by 1.3 percentage points on an annual average basis to 5.4 per cent at the end of FY 2024,” says Anuj Puri, Chairman, ANAROCK Group, a property consultant. “For investors prioritising consistent income and future appreciation, renting may prove more prudent, while maximising return on investment may favour selling during favourable market conditions,” says DeepanshuChhabra, Principal Partner and Sales Director at Square Yards, a proptech platform.
However, real estate as an investment is not meant for the average retail investor, because the first house you buy would be usually used to provide a roof over your head. “Investing into real estate comes with its own challenges, big ticket size, and returns are relative in nature. While over the long term they might beat inflation, it can go through long periods of stagnation as well,” says Siddharth Alok, AVP Investments, Epsilon Money mart.
However, retail investors now have an option to invest into real estate through small and medium real estate investment trusts (SM REITs). Investing through SM REITS is an effective strategy to safeguard your portfolio against inflation. “SM REITs allow you to diversify by including commercial real estate, a tangible asset, alongside traditional stocks and bonds, thereby spreading risk and providing a hedge against inflation,” says Shiv Parekh, Founder, hBits, a fractional real estate platform.
With a minimum ticket size of Rs 10 lakh, fractional ownership in commercial real estate offers two-way earnings. “These are regular monthly rental income, typically ranging from up to 10 per cent, which provides a stable income stream to offset inflationary pressures, and capital appreciation of up to 18 per cent over five to seven years, offering significant long-term growth potential,” says Parekh.
The Golden Inflation Shield
Traditionally, our mothers and grandmothers have bought and held on to gold jewellery. Based on the principle that diversification should include investing in uncorrelated assets, this is a wise decision. Generally speaking, gold and equities have an inverse relation. Gold is considered as a safe haven when there is economic uncertainty and the markets are underperforming.
“Gold is seen as an inflation hedge because it maintains its value and often rises in price when inflation is high. Unlike money, which can be devalued by excessive printing, gold has a limited supply. Historically, gold prices have increased during times of high inflation, making it a good way to protect wealth from losing value,” says Sachin Jain, Regional CEO, India, World Gold Council.
He adds that over the past 41 years, gold has delivered an average annual return of 10 per cent in rupees, clearly outperforming CPI inflation, which grew at an average of 7.3 per cent over the same period. Gold’s performance has also been particularly strong in periods of high inflation, increasing by 12 per cent on average when inflation rose above six per cent.
But investing in physical gold has its disadvantages. You need to store it properly and further, when you sell gold jewellery, you do not get the actual price of gold. There are several other options of investing in gold. These are investments that track the value of gold and thus help you to reap the benefits of investing in gold without buying physical gold. These include digital gold, gold mutual funds (gold exchange traded funds or ETFs which track the domestic gold price) and sovereign gold bonds (SGBs) which are government securities denominated in terms of gold and is a good option because there are no capital gains on tax when you hold it for eight years.
Now, we will look at three situations where inflation needs to be managed wisely.
Funding Your Child’s Education
All parents want to provide the best education to their kids, but here too inflation is one factor that can play spoilsport. A 2023 report by BankBazaar revealed that over the last decade, while CPI has been around six per cent, the rate of inflation in education has been significantly higher, at around 11-12 per cent. “We need to assess the amount needed for the child today for a particular course and extrapolate the expenses in the future. Based on that, we need to start putting money away in appropriate assets so that the target amount can be reached when the goal comes up,” says Suresh Sadagopan, founder and principal officer of Ladder7 Financial Advisories, a financial planning and wealth advisory firm.
To factor in inflation when planning kids' education in India, start by saving early; for example, saving Rs 10,000 a month from birth can significantly accumulate over time. “Invest in assets with returns above inflation, such as equity mutual funds, which have historically provided annual returns of around 12 per cent, outpacing the average six per cent inflation rate. Utilise tax-advantaged options like the Sukanya SamriddhiYojana for girls, which offers attractive interest rates and tax benefits,” says Alok.
Coping with Medical Bills
Inflation in costs of medical services is perhaps the scariest. The recent Covid-19 pandemic brought with it horror stories of how families had their savings wiped out due to more than one member of the family getting infected with Covid-19 at the same time. And medical inflation is rising at a much faster rate than normal inflation.
“Medical inflation consistently continues to outpace retail inflation. While retail inflation hovers around six to seven per cent, medical inflation in India has been clocking an alarming rate of approximately 14 per cent,” says Siddharth Singhal, Business Head - Health Insurance, Policybazaar.com, a digital insurance platform.
This stark contrast creates a critical need for health insurance as a shield against the rapidly increasing costs associated with healthcare, particularly in advanced and tertiary treatments.
A retail health policy covers all expenditures related to hospitalisation and treatment and ensures that individuals do not face financial distress during medical emergencies. “These are situations where even corporate insurance tends to fall short and one ends up bearing out-of-pocket expenses or compromise on the treatment, type of hospital or room category. A retail health policy provides peace of mind by covering significant healthcare costs, thereby mitigating the impact of medical inflation,” says Singhal.
One can prepare for future medical inflation by buying a mix of base and super top-up health insurance policy. “One can consider buying a Rs10 lakh cover as a base policy and then a Rs 90 lakh as super top-up policy with Rs 10 lakh as deductible. This way they can get a cover of Rs 1 crore at a low premium,” says Abhishek Kumar, Sebi RIA and Founder, SahajMoney.com, a financial planning firm.
Retirement Corpus
Many people become completely risk averse when they approach retirement. But with increasing life spans, there is a need to adapt. “Retired individuals should also invest a certain portion of their savings in equities to ensure that their overall portfolio yields higher returns and beats inflation,” says Shashank Pal, Chief Business Officer, PL Wealth Management. A modest 10-15 per cent exposure to equity even in the retired years gives one’s retirement corpus the much needed boost to stay ahead of inflation. ““If they are not willing to do that, they will have to be willing to live with a falling lifestyle over time,” says Sadagopan.
Hence, by planning your investments and getting the right exposure to equities, you can be the knight of smart investing and slay the inflation monster. Don’t let inflation steal your dreams, but conquer it like a superhero.
