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Inflation and best ways to deal with it

It kind of feels like everything is expensive these days, right? Petrol prices, fruits and vegetable prices, grocery bills, etc. It is so shocking to see that prices have increased so significantly for the same quantity you were getting a year before. Well, you guessed it right! Inflation is the harsh reality today and we all must face it.

How it shrinks your earnings?

Imagine a person from a salaried class earning INR 500 per year and trying to save 20% of his income for future. He kept INR 100 in his savings account at 4 % interest. After a year, he will have INR 104 in his savings account. However, if the inflation rate is running at 7%, he would require INR 107 to having the same purchasing power he has last year. He did gain money on savings but effectively lost his earnings. With each passing year, it will erode the value of savings and standard of living. In order to increase the purchasing power, one has to take measures to increase the nominal growth/return as inflation is beyond one’s control.

The recent rise in the inflation rate has surprised financial markets as well as monetary policymakers. In just one year, the annual inflation rate measured by the consumer price index (CPI) has increased substantially to 7.01% in June 2022.

Such high rate of inflation is primarily due to rise in prices of crude petroleum and natural gas owing to disruption in global supply chain caused by Russia- Ukraine war clubbed with COVID-19. So with the rise in petroleum prices, a corresponding increase gets added to all modes of transportation, which leads to increase in prices of all commodities, services and financial markets. These events have threatened our saving fund and increased the average cost of living across India.

Where to invest and how to invest?

So, while we all know what inflation is and does, the real question to ask is where should you invest your money to shield it from the invasive effects of inflation on your long-term wealth and savings by increasing the real income.

4 Ways to protect your savings

1. Invest in Inflation proof assets:

Gold: Gold is the real asset that holds its value under inflationary pressure. The metal has seen increase in its value even in COVID times making it a perfect investment. India as a country has purchased more than 150 Tons of Gold over last 3 years. The gold prices have jumped significantly in 2022 as compared to 2021. Over the first six months of the year, with the increase in inflation by 7%, the price of the yellow metal has also increased by around INR 4,000, seeing a rise of almost 8%. Also, the charm of gold never goes down in India and people prefer to invest in gold.

Home/Real Estate: When landlords and owners increase their prices over a period, investment in Real Estate acts as a shield against inflation. You can invest in real estate by directly buying it or investing into Real Estate Investment Trusts or REIT. REIT, is a company which owns, operates, and finances income producing Real Estate and it provides an opportunity like Mutual funds, for anyone to be a part of the valuable real estate and get income in the form of dividend, etc. Appreciation in Real Estate is fast as compared to other investments and its Net Rate of Return manages to shield us from impact of inflation. The total returns from investing in REITs rose in excess of 20 per cent in the year 2021, including dividends and capital appreciation despite COVID and inflation.

Inflation Indexed National Savings Securities: These are government bonds that mirror the rise and fall of inflation. For example, if the coupon rate is 5 per cent per year and the principal is Rs 100, the investor will be paid Rs 5 a year. If the inflation index rises 10 per cent, the principal will become Rs 110. The coupon will remain 5 per cent, resulting in an interest payment of Rs 110 x 5 per cent = Rs 5.5. They are thus designed to hedge the inflation risk of a bond. You can either buy these certificates through authorized banks or invest in mutual funds that own these bonds (eg: SBI Inflation Indexed Funds). Investors will be able to trade them in OTC market, stock exchanges like any other government security.

Commodities: Inflation is a general rise in prices. Commodities tend to be inputs into manufacturing processes or consumed by households and businesses. As a result, when prices rise in general, so should commodities. Accordingly, prices for raw materials like oil, metals, agricultural products and other household items increase along with inflation, so investing in in consumer commodities might not be a bad idea in time of increasing inflation.

One can invest in commodities by various modes i.e. buying the Commodity futures contracts over the commodity exchanges or buying exchange traded funds with commodity exposures. Some commodity ETFs buy the physical commodities and then offer shares to investors that represent a certain amount of a particular good.

2. Plan and Budget:

The alarmingly high prices is a wakeup call for all of us to keep a check on our daily expenses. Hence, it becomes important for us to be mindful of where we spend and how we spend. There is a very famous 50-20-30 budget rule popularized by Elizabeth Warren which states that divide up your after-tax income and allocate it to spend: 50% on needs, 30% on wants, and remaining 20% to savings, however in my view you should mandatorily first allocate 20% to savings and then re-align your needs and wants as per your income.

3. Invest in the right mix of equities:

You need to study the financial stock markets and choose the right mix of investment in equities of companies which are inflation-proof or will have a safeguard against the rise in prices due to inflation. Generally, large-cap or mid-cap companies having strong fundamentals and businesses tend to do well over long period of time in terms of real income growth. Inflation is bullish for oil companies and emerging markets stocks. However, one need to have an adequate mix of various type of investments to safeguard.

4. Invest in Yourself

You are your biggest asset that one can get in his/her lifetime- Invest in it. You can invest and get yourself into new professional courses which would enhance your learning skills and capabilities and result in higher income generation.

With the recent trends and events, it is seeming that inflation is here to stay. To ensure a safe future, be cognizant and start investing today.

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April 2024