Inflation, or the year-on-year increase of prices, is probably the main reason why someone would even think about investing.
Inflation doesn’t discriminate. Prices keep going up over time for all of us regardless of where we sit on the socio-economic scale. Inflation does the most damage to retirees and those living on a fixed income. Typically, they’re more dependent on income from their investments than people still collecting a regular paycheck.
Consider this; if 8% is the average inflation every year, and you can buy something for Rs 100 today, 10 years from now, to buy the same thing, you will need Rs 215.89. In other words, Rs 100 today is worth only Rs 46.32 in today’s value terms after 10 years.
Unless your investment earns you a decent return above and beyond expected inflation rate, your money can actually become worthless.
The question then becomes: how do you beat inflation?
Let’s talk about the lazy man’s approach to investment. Some people call it “invest and forget”. However, as you will see from the following statements, it isn’t smart to just “forget”.
What is “invest and forget”?
Invest and forget is an investment strategy wherein you invest in certain instruments such as company shares, mutual funds, or even real estate, and simply forget about them. Make regular payments and don’t track what’s happening to your investments.
The reasoning is that over a period of time, your investments will always grow in value.
What really happens here?
If you invest and forget that you have invested, it’s like rolling a dice. Your investments will perform randomly based on multiple factors, including pure dumb luck.
Invest, but own your investments. If you invest in a business, wouldn’t you want to check its performance periodically? Similarly your investments require periodic health checks. The frequency on the other hand should be on the lower side.
Benjamin Graham, one of the greatest investors, said that if you track the markets too frequently then it is like listening to the ravings of a deranged person. The markets moves between extremes, which if frequently followed will do you more harm than good.
A periodic check, perhaps once a year, is ideal for tracking your portfolio of investments. Invest, but track every year.
Can they beat inflation?
Equity, in the long run, is proven to offer better returns than any other investment. However, equity is also fraught with risk. You can minimize this risk by leaving the management to professionals and invest in consistently performing equity mutual funds.
As for beating inflation, “invest and watch occasionally” is the best way to avoid the hassle and yet, keep your wealth accumulating.
The right way to do “invest and almost forget” investing
If you really want to minimize your effort but want market beating returns, you need to invest in equity mutual funds. Here are some basic rules to follow to invest well:
#1: Diversify your investments but don’t overdo it
Mutual funds by their very nature, diversify your portfolio. Holding tens of mutual funds does not lead to better diversification. Have a manageable number of mutual funds in your portfolio.
#2: Have a flexible but overall consistent investment approach
Moving your investments across sectors in the markets or across too many companies too frequently will dilute your returns. Pick a strategy and stick with it.
If you are not very well versed with industries and companies when it comes to equities, go with diversified equity mutual funds. A fund manager, whose full time job is investing, is best placed to take calls on sector and asset allocation.
#3: Pick the right funds
Go with a mutual fund with a good track record to minimize risk and maximize gain.
However remember this; past performance is not a guarantee of future returns. So check your portfolio performance annually and re-think your investments if needed.
Stay married to equities; not particular funds.
#4: Follow a disciplined investing approach
Compounding is your friend.
Invest regularly; invest whenever you have money. Over time, your money will compound and start working for you.
#5: Give your investments time
Getting rich quick is normally a pipe dream. Historically, consistent investments in equity markets take at least five or more years to give inflation beating returns with the lowest possibility of making losses.
If you have made the right investments, give it time. Patience, not haste, will make you rich.
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INVEST IN EQUITIES/EQUITY MUTUAL FUND:
inflation-1_new_650_073014042406Investing in equities over a long period is one of the best ways to stay ahead of inflation. Over the last 10 years, the Nifty has returned 16.7% a year compared to the 7% average inflation rate. One can either invest directly or through mutual funds. For small investors, it is advisable to invest through mutual funds, as they are managed by experts.
Anil Rego, chief executive officer, Right Horizons, says investors should look at diversified equity mutual fund schemes to earn higher risk-adjusted returns. However, equity investments should have a horizon of at least three years, sometimes even longer.
Another way of lowering the overall risk is investing via systematic investment plans or SIPs. The compounding impact of such investments over long periods will help you beat inflation by a comfortable margin.
INVEST IN DIVIDEND-PAYING STOCKS:
One good way of staying ahead of inflation is buying stocks that pay good dividends. Interest rate offered by banks is usually much less than the inflation rate.
While investing, always focus on what is the real return or the return net of inflation.
Managing Director, Ladderup Wealth Management
“Dividends are a tangible return paid by companies and keep up with inflation,” says Raghu Kumar, cofounder, RKSV, an online share trading company.
Just like inflation, dividends, too, can be calculated annually. This figure, called the dividend yield, can be measured by adding dividends received during the year and dividing it by the stock price. The yield must be higher than the annual inflation rate.
ASSETS LIKE GOLD AND REAL ESTATE:
Gold is considered an ideal hedge against inflation. Market experts say real estate can also be an option if one can afford to spend a big sum. However, only a small part of your portfolio should be allocated to these options.
Asset allocation is critical. In this, one can look at an opportunity is to diversify globally. This will make your portfolio more stable and less vulnerable to domestic volatility and inflation.
These bonds are a great way to beat inflation as they are designed to protect both principal and interest.
The basic mechanism of an IIB is quite easy to understand. Assume that the annual coupon, that is, the amount the investor receives at the end of the year on his bond investment, is 7%, and he has invested Rs 1,000 (his principal); in this case, he originally would have been paid Rs 70 at the end of the year. However, assume that the inflation index for the year is 10%. Through an IIB, the 7% coupon is then applied to the new principal of Rs 1,100 (10% of Rs 1,000 + Rs 1,000), which comes to Rs 77 plus Rs 100 increment on the principal. Thus, the investor is sure to generate a return higher than the inflation rate.
“The principal is indexed to inflation and, hence, IIBs safeguard principal from inflation,” says Rego.
Vikas Gupta, executive vice-president, ArthVeda Fund Management, says, “Inflation index bonds are widely available securities in the developed markets that offer inflation protection to retail customers.”
RE-ALIGN YOUR PORTFOLIO:
During periods of volatility and high inflation, it is imperative for an investor to reassess his/her asset allocation taking into consideration risk, times horizon and goals. At the same time, it is equally important for an investor to take a long-term view so that his reaction to developments in the market is not knee-jerk.
For example, if one were to look at the Sensex from 2009 onwards, one might be shocked to find that the index has actually has gone up almost 110% during that time (an annualised rate of almost 17%).