BEATING
INFLATION
How much money did we make when we
started to earn and how much do we make today? But the lifestyles we aim to
maintain currently still remain elusive. For example, we all want to buy a
house of our own but most of us still struggle to afford one even with our
increased incomes. Come to think about it, while our incomes continued to grow,
so did the prices of the goods and services we consumed. This phenomenon of
rise in prices is called 'Inflation'. Technically speaking it is a sustained
increase in prices of goods and services.
This occurs simply because the demand for things we consume goes up in relation to their supply. Take example of a commodity like petrol. We all know that the prices of petrol have been consistently rising over the years because we have started consuming it more compared to the past. But relative to its demand its production has not gone up. Similarly, the prices of major items like food and other services have gone up. Inflation is generally indicated by a measure called Consumer Price Index (CPI) which comprises prices of various commodities and services commonly consumed. The chart below shows the rise in values of CPI over the years.
So how is inflation related to investing?
Inflation eats into the overall returns generated by our investments leading to lower net returns for us. For example, if our investment over the past year has generated a return of 10% and the inflation was 8% then we would be only left with a net return of 2%. These net returns are called as 'Real Returns'.
Now consider this, if in the year 2012 you invested in fixed deposit thinking that you made a return of 9%. Now, the inflation in that year was 11.17% …so in fact real or net return that you made that year was (-2%). This means that your investment actually made a loss! Thus the impact of inflation depends upon the type of asset classes you invest in.
How should we invest to beat Inflation?
While investing, our aim should be to maximize these real returns in order to grow our wealth. This can be achieved simply by investing in asset classes that have produced excess returns over inflation. For example, equities have generated much higher returns over inflation compared to say fixed deposits.
The table below shows comparative real returns given by these asset classes.
This occurs simply because the demand for things we consume goes up in relation to their supply. Take example of a commodity like petrol. We all know that the prices of petrol have been consistently rising over the years because we have started consuming it more compared to the past. But relative to its demand its production has not gone up. Similarly, the prices of major items like food and other services have gone up. Inflation is generally indicated by a measure called Consumer Price Index (CPI) which comprises prices of various commodities and services commonly consumed. The chart below shows the rise in values of CPI over the years.
So how is inflation related to investing?
Inflation eats into the overall returns generated by our investments leading to lower net returns for us. For example, if our investment over the past year has generated a return of 10% and the inflation was 8% then we would be only left with a net return of 2%. These net returns are called as 'Real Returns'.
Now consider this, if in the year 2012 you invested in fixed deposit thinking that you made a return of 9%. Now, the inflation in that year was 11.17% …so in fact real or net return that you made that year was (-2%). This means that your investment actually made a loss! Thus the impact of inflation depends upon the type of asset classes you invest in.
How should we invest to beat Inflation?
While investing, our aim should be to maximize these real returns in order to grow our wealth. This can be achieved simply by investing in asset classes that have produced excess returns over inflation. For example, equities have generated much higher returns over inflation compared to say fixed deposits.
The table below shows comparative real returns given by these asset classes.
|
Asset class
|
5 year compounded return (%)
|
Average CPI increase over 5 year (%)
|
Real Return (%)
|
|
CNX Nifty
|
9.50
|
8.42
|
1.08
|
|
Average Bank FD rates 5 years back
|
8.25
|
8.42
|
-0.17
|
As on 30th June 2015. Source : onemint.com and inflation.eu
As is evident from the table, equities have generated much higher returns beating inflation. However do keep in mind your risk profile in mind while taking exposure to these asset classes.
Mutual Funds offer a range of schemes with varying options to take exposure to assets which have the potential to generate real returns that can suit your risk profiles. There are schemes like:
As is evident from the table, equities have generated much higher returns beating inflation. However do keep in mind your risk profile in mind while taking exposure to these asset classes.
Mutual Funds offer a range of schemes with varying options to take exposure to assets which have the potential to generate real returns that can suit your risk profiles. There are schemes like:
- Monthly Income Plans (MIPs):
Generally offer equity exposure up to 20%.
- Balanced Funds: Offering a
higher equity exposure ranging from 50% to 70%
- Pure Equity funds: Offering
highest equity exposure.
- Gold ETF: Offer exposure to
gold
So be a prudent investor and invest
wisely to beat inflation. This will help us to maintain as well as enhance our
lifestyles.
Happy investing!! …source Kotak Mutual Fund
Happy investing!! …source Kotak Mutual Fund
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