Ways to beat inflation

The solution is to invest in high-growth asset classes like equity and real estate. And these come with their issues of volatility and illiquidity respectively. The portfolio should have a balanced approach to generate both regular income and capital appreciation

If one has invested in a 3-year fixed deposit in 2011, it would have given about 9.25 per cent per annum. This seems good considering the risk-free (almost) nature of the instrument. But, a careful analysis throws that one has actually made a negative return. It’s because the average Consumer Price Index (CPI), which measures the increase in the cost of goods, during that period was 9.36 per cent. This ends our investment real return at -0.11 per cent i.e. the fixed deposit has depreciated. In simple terms, one could purchase lesser goods now than with the original value then. This is called inflation or interest rate risk.

Inflation is a clear and present danger one needs to consider while making investment choices. Each investment is subject to inflation/interest rate risk or opportunity risk. If your investment has not given returns beyond the inflation during that period then inflation risk has affected. For instance, if one has ignored stocks during the same period, now one could’ve lost the opportunity of higher returns, as the markets peaked now. This is the loss caused due to not participating in the opportunity. Inflationary issues have been hogging the headlines in the past few years and there seems not much respite in the near future. With rise in the diesel prices and it’s rollover on to the transportation costs, the cost of goods seems only set to go up. Add to experience of fickle weather both weak and excessive rains have only hampered any chances the government tried to rule over. So, is there a way out?

The obvious solution is to invest in high-growth asset classes like equity and real estate. And these, however come with their issues of volatility and illiquidity respectively. The portfolio should hence, have a balanced approach to generate both regular income and capital appreciation. Every asset class has its own cycles and one should invest with a goal to ensure completing these cycles or opt for an investment that suits the time period of that need.

For long-term and high corpus needs like children higher education and retirement, it’s always beneficial to opt for investment in equity. For instance, the diversified equity MF have generated returns of over 30 per cent and beating the inflation by over 20 per cent during 2011. But, there was a lull and again the last one year returns have been quiet tremendous. Equity assets provide super-high returns in bursts and one need to be adequately exposed to gain from these opportunities.

So, that leaves with an obvious question of parking the entire monies into equity. The answer is an emphatic ‘NO’. Equity exposure should be aligned with ones risk appetite and moreover, should be in line with the needs and their timelines. The best way to reduce the risk in equities is to have a disciplinary (systematic) approach, diversify across the markets and stay invested for an entire cycle (bear to bull). Also, a decent proportion to real estate, bonds and gold would do well for diversification of the investments.

What I’ve not mentioned in the above example is the taxation. If the interest from the FD is taxed then the real returns would be even lower. This is something that equities address quiet well. When held for periods of 1 year and above, attracts zero taxation on the gains. This would turn into a boon for the investors in the long run, with the effects of compounding appreciation.

(The author is a practising financial planner and can be reached at [email protected])