Author: Khushi Doshi
Co-Author: Balkrushna Vaghasia & Mrunal Shah
“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”
-By Sam Ewing
Inflation is not a one-time event when people say, "mehangai badh rahi h", but rather a continuous phenomenon that gradually reduces your purchasing power. Inflation's effects may appear minor in the short run, but they have a significant impact over time.
Don't be appalled by the facts that we are about to tell you, we won't leave you in trouble without offering appropriate solutions for it.
The ensuing table shows how your money in hand is consumed by inflation in about 20, 10, and 5 years :
As the table clearly depicts, the value of Rs. 1,00,000 earned and kept in a pocket for respective periods reduces drastically. The effects of inflation significantly impact our purchasing power. If the money is not allocated to appropriate assets, you could end up losing your accumulated wealth with a huge compounding effect.
Though it may be frustrating to think about the rupee losing its value, most economists consider a small amount of inflation as a sign of a healthy economy. A moderate inflation rate encourages you to spend or invest your money now rather than burying it under your mattress and watching its value deteriorate. Therefore, it is critical to invest your money so that the value of the money you hold does not depreciate and you prosper over time. It is no longer sufficient to earn a living from your business or job; the only way to be efficient is to invest. The preceding statement is explained by a well-known Warren Buffet quote: "If you don't find a way to make money while you sleep, you will work until you die".
How to tackle inflation?
We have already acknowledged the fact that investment is important in beating inflation. Now the question is, how do we invest, and what else, aside from investment, is required to combat the colossus?
Individuals must safeguard their wealth from deterioration. There are both conventional and unconventional methods for dealing with inflation. The following methods have an advantage over others because they have demonstrated the ability to generate balanced returns over time:
Investment driven methods:
● Investment in Equity
● Investment in Gold
● Purchasing Government Bonds or Corporate Bonds
● Diverse Geographically
● Investment in Real Estate
● Commodities Investment
2. Other methods:
● Invest in Yourself
● Limit Your Needs
● Judicious Emergency Fund
Investment driven Methods:
Investment in the Equity market:
We would prefer to say invest in good businesses instead of invest in the equity market. If there is one sure-fire way to outperform inflation over long periods of time, it’s investing in businesses. Many businesses are able to not only pass on rising prices to their customers but also increase their profit per unit of sales.
There isn't a billionaire who has become a billionaire by keeping the money in a fixed deposit or savings account. There are a plethora of opportunities in the equity markets that can be monetized and used to increase your wealth. As Indians, we have an advantage over others. India is one of the world's fastest-growing economies, which presents a golden opportunity for any investor.
To provide you with statistics on the statements, let me link the growth in GDP over the last 20 years to the growth in returns provided by the BSE Sensex.
You can clearly observe that the correlation between the return of the Sensex and GDP growth is positive. Historically, corporate profits have grown at a rate higher than the GDP growth rate. Prices of equity move in tandem with corporate profits in the long term. Accordingly, with time the index is bound to elevate and provide great returns. We do not intend to imply that these returns are guaranteed if you trade the market blindly. Speculation won't lead you to such returns, but investing prudently surely can.
Do you understand the relationship between equity returns and the inflation rate? Don't be jittery. We'll let you know in our next blog, so keep an eye out.
Investment in gold:
Investing in gold has always been thought to be a safe bet. We've all heard it, but there's a reason why people with and without a risk appetite say it in unison. The graph below shows that the increase in the rate of return on gold is greater than the inflation rate for most of the years.
Gold prices fluctuate as well. But, in the longer term, they are considered safe in the portfolio as it is important for your portfolio to be diversified.
There are several ways by which you can invest in gold apart from purchase of physical gold. The options are -
● Physical gold
● Gold ETFs
● Gold mutual funds
● Sovereign gold bonds
● Digital gold
We'd like to remind you once more that investing is advised because it generates returns on your hard-earned money. These returns enable you to outperform inflation by providing returns that are higher than the rate of inflation.
Investment in government bonds and corporate bonds:
This is the most secure investment. However, safety comes at the expense of the lowest returns. There are two reasons why such an investment is advised. One, these investments are intended for those who are risk-averse. Two, depending on the type of bond chosen, there are tax advantages to such bonds.
Corporate bonds provide returns higher than those of government bonds. Though these bonds may have been secured by tangible assets of the issuer company, there is no sovereign guarantee regarding the repayment of the principal and payment of interest. Corporate bonds in India usually provide interest rates higher than the inflation rate, depending upon the credit rating of the issuer company.
Diversify geographically:
Any savvy investor knows you can't put all your eggs in one basket. When you have investments in different geographies, your total investment portfolio is protected from hyperinflation in your home country or any one country. Hyper-inflation is usually a country-specific issue.
Investment in real estate:
Investment in real estate provides continuous cash flow through rental income. If chosen wisely, an increase in the value of the property can be a good hedge against inflation as it has the potential to generate significant long-term returns. The prices of real estate increases as a result of economic growth despite the presence of sufficient supply as the replacement cost involved in real estate is very high. Urbanization is another major factor driving up real estate prices as people prefer to live and work in the developed or developing vicinity, causing demand pressure.
The ensuing graph depicts the increase in the residential index from 2014 to 2020.
There is also an option for those who do not wish to purchase the properties. They can invest in real estate investment trusts (REITs). A real estate investment trust (REIT) is a business that owns, operates, or finances income-producing real estate. REITs, which are similar to mutual funds, pool the capital of multiple investors. Individual investors can now earn dividends from real estate investments without having to buy, manage, or finance any properties themselves.
Commodities investment:
First and foremost, let us be clear with what commodities mean. commodities are often split into two broad categories: hard and soft commodities. Hard commodities include natural resources that must be mined or extracted—such as gold, rubber, and oil, whereas soft commodities are agricultural products or livestock—such as corn, wheat, coffee, sugar, soybeans, and pork.
Though you can buy physical commodities from the open market, it is not the most efficient way. There are sophisticated commodity exchanges that provide the facility of purchasing physical goods and derivative contracts. The physical commodities are usually bought on the exchange by institutional investors to realize gains by selling in the retail segment of the country. You as an individual are advised to invest in mutual funds that trade in the commodities market because commodities encounter volatile cycles. The cycles are difficult to understand and predict and hence it is recommended to consult the experts who have knowledge about it. During the last five years, the average return provided by mutual funds has been around 8% per year.
Other Methods:
Limit your needs:
“One of the great defenses to being worried about inflation is not having a lot of silly needs in your life,” Charlie Munger told Berkshire shareholders back in 2004. Inflation jacks up the prices of almost all goods and services in the long term.
However, you don’t need to worry a lot if you don’t want to buy them. Since you don’t need unnecessary goods and services, you will be largely unaffected by the ballooning prices. On top of that, you can invest the money you didn’t spend to compound your wealth, ultimately hedging the inflation efficiently.
Invest in yourself:
The best investment you can make is in yourself. Try to improve yourself on a daily basis, becoming more adaptable to any situation and learning new skills, because this is what pays the best dividends. Back in 2019, Warren Buffett said in an interview “If you’re the best teacher, if you’re the best surgeon, if you’re the best lawyer, you will get your share of the national economic pie regardless of the value of whatever the currency maybe.” In other words, being great at what you do will ensure that you receive your fair share no matter what is happening with the value of the dollar.
Judicious Emergency Fund:
Though negative consequences of holding idle cash have been discussed previously, there is a need to keep cash on hand for short-term purchases. You should keep an emergency fund through which you can purchase 3-5 years' worth of basic needs to maintain your current lifestyle. While making a provision for this emergency fund, make a fair estimate of your needs and avoid excess stockpiling of cash.
Conclusion:
There are several ways to hedge against inflation. However, equity provides the highest returns. Don't believe me? Let's see what statistics have to say about it.
Don't run to purchase stocks, wait there! Investment in equity is without a doubt the best solution, but it is critical to understand how to do so. Some people believe that they are fated to profit from the stock market and that those who do are fortunate. But nobody gets lucky forever, and there are numerous examples of people that we can provide you with. It is critical to seek advice.
Those who do not want to take on a lot of risks have other options besides equity. The most important thing to remember is to invest and use any of the inflation-beating alternatives.
And, yes, we will triumph over inflation. We're in it together. See you in the next blog.