“The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil.”

– Warren Buffett, CEO, Berkshire Hathaway

A liquid savings of Rs 1 lakh a year can fetch you some security as you celebrate your 30th birthday. Thirty years on, you’ll find it’s down to a meagre Rs 15,625 in today’s value.

So, who moved your money?  It’s inflation, assuming an average rate of around 6 per cent to sustain through the period. And, if the Reserve Bank can put a leash on the falling purchasing power of the currency to its mandated 4 per cent level, then you could be a bit lucky with your annual savings being worth around Rs 29,385.

That was an instance of the possible erosion to investments inflationary waves can cause. High inflation environments have plagued India time and again along the country’s economic journey. The hydra-headed monster has once again cast a shadow on your investments.

Consumer prices, which track the retail prices of a basket of goods and services, have accelerated at over 4 per cent annual rate for 21 months in a row and shot past the 6 per cent cap more than 12 times. Wholesale prices have been rising even faster. Although the Consumer Price Index (CPI) eased in July to 5.59 per cent, that may primarily be due to the high base effect as in the corresponding period of last year, it was 6.73 per cent.

A major cause for concern is the rise in wholesale prices. According to provisional figures from the Office of Economic Adviser, Department for Promotion of Industry and Internal Trade, the annual rate of wholesale price inflation (WPI) — which measures the change in the price of goods traded in bulk by wholesale businesses and doesn’t include services — was 11.16 per cent in July. Though this was a tad lower than 12.07 per cent recorded in June, such high WPI numbers may push consumer price inflation (CPI) further.

As the cost of living swells, your returns do not grow in sync. The best way to wriggle out of this crisis is to set your money on a growth engine that outpaces the rate of inflation over the long term and not only retains its value, but also grows with time.

“These are interesting times, not in a good way though,” feels Gaurav Udani, Founder and CEO of ThincRedBlu Securities. He says that high inflation rates in a normal scenario are accompanied by healthy interest rates, reflecting that inflation is being fuelled by a demand spurt, creating a healthy economic environment that makes it a win-win for the entire ecosystem.

But that’s not the story this time. “Such trends were seen in 2003, 2007, 2014 and so on. Today, inflation is not being pulled by demand but is being pushed by cost and supply-side constraints, which indicate that consumers do not have enough resources but are being forced to pay more for the same products and services,” he says.

The supply-side challenges can be resolved without much delay but a revival in demand takes long. It is even more crucial to preserve the value of your money in this environment. Asset allocation is of supreme importance to hedge your money. Equities, known traditionally as an instrument to beat inflation, rank high as you review the different asset classes to park your money. Udani says the only way to beat inflation is by allocating 50 per cent of the corpus to equities.

“There is no other way one can achieve this. Historically, across the world, only equities have allowed investors to beat inflation. Having said that, markets are heated right now and despite the recent correction, Nifty is at a trailing PE of 30, which suggests that more correction is on the cards either by value or time. Investors, in my opinion, should remain invested in three major classes: equity, debt and gold, according to their risk appetite,” he says.

Equities have breached historic highs in the last couple of months with the BSE benchmark Sensex shooting past the psychological 56,000 mark for the first time and the broader NSE Nifty topping the record 16,500 level in early August. But the rise has not been consistent in a world battered by the pandemic. Wild volatility in the indices have often left investors worried about their money in recent months.

If the equity exposure is less than 10 per cent of your portfolio, then your portfolio is not beating inflation. “Hike it to at least 15-20 per cent of the portfolio. Even retirees cannot afford to stay completely away from equities,” says Raj Khosla, Founder and MD of MyMoneyMantra.com.

The government’s efforts to tackle the Covid crisis has led to a liquidity flush in the system, while the containment measures imposed by the authorities have triggered supply-side constraints. The two factors have added up to the spurt in inflation. India’s projected growth in gross domestic product has been revised downwards by most rating agencies. A healthy monsoon, lifting of movement restrictions and a successful vaccination drive are expected to give the wobbly economy the support it needs to firm up. But all these would force the RBI to maintain a low interest rate regime which, in turn, would keep inflation at an elevated level in the near future.

“In scenarios like this, the art of portfolio rebalancing is what separates winners from losers. Those who stayed put with a higher allocation towards debt instruments would have seen the real value of their investment shrinking, while those who moved to equity in the last two years would have seen their investment yielding handsome returns,” says Anurag Jhanwar, Co-founder and Partner at Fintrust Advisors. “Also, equity investors may increase their exposure to sectors that are stable or could potentially even gain from high inflation, like BFSI, FMCG, and energy.”

As India limps out of the pandemic woes, a global spike in crude oil prices has come like a blow. Petrol and diesel prices have shot through the roof, driving the cost of goods and services to new highs. Khosla says that inflation is likely to remain high in the coming months due to the “incessant increase” in fuel prices. “Normally, if high inflation exceeds the comfort zone, the RBI steps in to cool things down by hiking interest rates. But, given the present situation, the central bank has indicated that it will not hike interest rates.”

Khosla prefers more traditional options when it comes to hedging investments. “Fixed-income investments will deliver a negative real rate of returns for investors. Although bank deposits are offering only 5-6 per cent, small savings rates have been kept unchanged. Instead of going for bank deposits, investors should consider these post office schemes where interest rates are higher. In the long-term, only growth assets like stocks can help you beat inflation,” he says.

Many investors look at the nominal rate of interest from an investment that doesn’t adjust for inflation. The real rate of interest can be arrived at by subtracting inflation from the nominal rate of interest. For instance, a bank fixed deposit may offer an interest rate of 5 per cent for one year. If inflation is 4 per cent for this period, then the real interest rate is only 1 per cent.

“Rising inflation can impact your long-term financial goals if you invest predominantly in fixed-income assets. It is because inflation eats into your return and you take long to attain your financial goals,” says Archit Gupta, Founder and CEO, Cleartax. “You will have to change your strategy by investing in inflation-indexed bonds that adjust the principal and interest for inflation. Investors with a higher risk tolerance can invest in equities for inflation-beating returns over time.”

Inflation affects different investments differently. Long-term bond funds could be hit badly, fears Khosla, and so it is better to switch to short-term funds. “Stock markets will be a mixed bag. Producer industries (oil and gas, metals, commodities) will register higher revenues, but consumer industries will see their margins squeezed. Oil prices are on the boil, but markets see higher foreign inflows during such periods as oil-producing countries deploy their wealth in emerging markets like India,” he says.

It’s a good idea to take some tactical exposure to gold in such pressing times, according to experts. Gold preserves your purchasing power, and is a good hedge against inflation. In fact, gold shines brighter when inflation is up.

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Use the Power of Compounding

The power of compounding is the reinvestment of earnings at the same rate of return, growing the principal amount you invest over time. Equity funds offer the power of compounding benefit if you reinvest dividends to purchase more units of the fund, according to Archit Gupta, Founder and CEO, Cleartax. Here is how you can get the power of compounding benefit.

• Invest for the long term to give equity investments the time to grow.
• The power of compounding is magnified with equity investments as they may offer a higher return on investment than fixed income instruments over time.
• Invest in equity funds through a systematic investment plan (SIP). It helps you invest small amounts periodically in equity funds and average out the purchase price of units over time.
• Choose the growth option with equity funds where your returns (dividends) are automatically reinvested to help you get the power of compounding benefit.

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Investment Instruments to Beat the Inflation

Fixed Deposits

People invest in bank FDs as they are considered a safe investment avenue. However, bank FDs offer lower interest rates on deposits across tenures in a falling interest rate scenario. Moreover, you get a negative real interest rate from investments in bank FDs when adjusted for inflation.

Small Savings Schemes

Small savings schemes such as PPF offer an interest rate slightly above the inflation rate along with tax benefits. It could be a suitable option as it helps beat the inflation over the long term.

Debt Funds

Rising inflation may result in RBI hiking interest rates at some point. Bond prices have an inverse relationship to interest rates, and higher interest rates could lower bond prices. It impacts debt funds that have bonds of longer duration in their portfolio. Debt funds with a higher proportion of long-term bonds in the portfolio experience a fall in the net asset value (NAV). Rising interest rates are positive for debt funds that invest in short maturity bonds such as liquid funds, as they can invest the maturing investments at higher interest rates.

Gold

Gold investments are a traditional hedge against inflation. People invest in the safety of gold when inflation is on the higher side, pushing up gold prices. Experts recommend that you allocate around 5-10 per cent of your portfolio towards gold to diversify your portfolio.

Equity Funds

Equity funds have done well when inflation is at slightly higher levels, but not too high levels. However, in the current rising inflation scenario, equity investments have the potential to offer inflation-beating returns over most fixed income instruments over time.

vishav@outlookindia.com