How to Beat Inflation

How to Beat Inflation

Most of us relate to inflation only by rising milk, corn or onion prices. Inflation has much wider and threatening repercussions on your purse than this. Before jumping onto understanding “how to beat inflation”, lets understand the inflation and the risks associated with inflation

The risk of inflation upsetting your financial plans is not theoretical; it is very real, for mainly two reasons.

First, inflation in India is usually discussed in terms of the Wholesale Price Index (WPI), which captures product prices at the factory level. But it is the Consumer Price Index (CPI) that better reflects products and services used by middle-class consumers. Annual inflation in the CPI (8 per cent) has consistently stayed well above WPI (6 per cent) in the last five years.

Second, inflation has inched higher steadily in recent years, with a rising middle-class stoking demand for everything from apartment blocks to vegetables.

Therefore, while financial advisors in India have traditionally used a 5 per cent inflation rate to construct long-term investment plans, inflation today is already twice than that level.

Read more at – what is inflation

How to beat inflation

1. Short term deposits and funds

Typically, in inflationary times one should not lock money in long-term and in fixed deposits with a longer tenure (over 1-year). This is because rising inflation is generally followed by rising interest rates.

Banks/institutions raise their deposit/coupon rates so investors who are already invested in these deposits/bonds witness what is known as an ‘opportunity loss’. However, fresh investors will clock a higher return on their deposits/bonds. Therefore, when there is even a likelihood of rates on deposits/bonds rising, choose short-term deposits. These investments will give you the required liquidity you need while ensuring that you do not lose out in case interest rates were to rise.

Example. During 2010 India saw rise in inflation rate coupled with rise in interest rate. Interest rate which was somewhere between 6.5-7% on 2 year deposit later increased to 8-8.5% increasing 200bps.

2. Precious metal

World currency value was linked to gold before Bretton woods era. Central banks all around the world stock up gold reserve for their currency. This is the clue one should grab from central banks action. In inflationary environment people flock to gold to safe guard their currencies. Currency loses its power as everybody starts selling the currency and start stocking gold.

Gold exposure can be taken either through Gold ETF (Kotak Gold ETF or Reliance Gold ETF) or through physical purchase of gold. It is a natural hedge against loosing currency value. So one should be aware of this situation and certain part of saving portfolio should be diverted towards gold investment.

3. Invest in inflation linked bond

This is natural hedge against inflation. It works something like this: suppose you are buying bond $100 face value for 5 years having 5% coupon rate. This is normal bond characteristic. But in inflation linked bond the coupon rate is(x+5) % where x is inflation rate and principal repayment is also linked with inflation. Now suppose inflation is 2% then the effective coupon rate will be 7%. Again let us imagine inflation slips to 1% then coupon rate gets adjusted to 6%. So whatever be the inflation your real purchasing power is not getting diminished.

These kinds of bonds come with lower coupon rate. Though this type of instrument has not been floated in India yet but RBI is in advance stages to introduce it for the long term investors say 10-12 years.

4. Investment in equities

Past data indicates that equities have given positive return if someone adjusts it for inflation. Nifty has generated 13.13% CAGR during last 10 years. Nifty return is much higher than inflation which on average hovered around 5-8% during last decade. But this is not a safe bet as equity investment needs certain special skills.

Therefore, for a common man it is not recommended to invest in equities without taking advice from financial advisor.

5. Get the Raise

Inflation means you’re getting a built in pay cut of at least 8% (if inflation is 8%) every year. In the next few years, that’s going to get worse… a lot worse. This means that now, more than ever before, is the time to focus on working harder and doing things that will get you noticed. At this point, getting a raise is often still just a defensive measure.

How to beat Inflation – Conclusion

Remember, the laws of economics don’t change just because we’re having a financially tough time. If anything, this is the time we should focus on the economic and financial principles that get us to prosperity. So while inflation is a concern there is no need for you to be a sitting duck every time it rears its head.

It is not that you have to do something “special” to tackle inflation, instead you have to stick to what you already know. To handle extreme financial crunches, you need to prepared beforehand.


About the Author

Anand is an Equity Research Analyst. His interest includes Economics to stock market analysis. He enjoys reading Charlie Munger, and Warren buffet behavioral finance philosophy

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