How Inflation Affects Your Investments

How Inflation Affects Your Investments

Introduction

“Inflation is a far more devastating tax than anything our legislation has enacted” – Warren Buffet.

In December 2021, India's inflation rate measured by the Consumer Price Index(CPI) rose to 5.59% from 4.91% in the previous month.

From 2012 to 2021, the average inflation rate in India was 5.97%. In November 2013, it reached an all-time high of 12.17%, and in June 2017, it reached a record low of 1.54%.

Source: https://tradingeconomics.com/india/inflation-cpi

In the past, you might have bought a bar of chocolate for say Rs. 5, now the cost of that same chocolate might have risen to Rs. 10 or more.

Why does this happen?

This happens because living costs are constantly increasing, or we can say because of inflation.

When there is a gradual increase in the prices of goods and services over time, it is known as inflation.

Inflation is caused when the demand for goods and services exceeds the available supply, causing a rise in prices.

Inflation can also be said as a decrease in the buying power of the money over time, i.e., an individual will effectively be able to buy less with the same amount of money next year than he did today.

Read more- How to invest in bonds in india

How does inflation impact your investments?

Inflation is a significant parameter that an investor is advised to consider before investing.

It is crucial that with the rise in inflation, the amount an investor is investing should rise at the same rate, but it may not happen.

Due to inflation, the investment amount (capital invested + return) may fetch a lesser number of goods after a few years.

If investors earn, say, 6% return, they might be satisfied. However, investors are just looking at the nominal rate of return and not the real rate of return.

Check also- Why bonds are the best investment option in 2022, 7 important alternative investment to invest in India, Know about Stocks, Bond & Mutual Funds

Nominal Rate of Return – Inflation = Real Rate of Return

Here, if the inflation is 5%, investors will only be earning a 1% return (6%5%). If the inflation is, say, 7%, then they will make a negative return of -1% (6%-7%).

So, it is clear that inflation will reduce the purchasing power and will eat away the real return on your investments.

Inflation can have several negative consequences for investors, including decreased purchasing power and reduced profits.

If investors want their investments to be protected from inflation, then their investments should earn more than inflation.

If investors want to make safe investments, they can buy bonds online in India such as government bonds, tax-free bonds, zero coupon bonds, corporate bonds through BondsIndia.

How to defend your portfolio against inflation?

Inflation cannot be avoided entirely. However, investors can have a strong strategy that can help minimise the impact of inflation on investments.

• One of the ways through which investors can defend their investments against inflation is to diversify their portfolios. If investors invest in a mix of instruments, such as bonds, equity, mutual funds, gold, etc., their average return might beat inflation.

• Investors can also invest in market-linked debentures, one of the fixed investment options, where the returns are not fixed but they are linked to the market. The return in these debentures is based on the performance of the underlying index, which could be equity benchmark, government yield, gold index, etc.

If you want to know more about market-linked debentures and invest in bonds online, click here.

You can also see- how to invest in bonds online, how to invest in high rated bonds and how fed interest rates affect bonds market.

Conclusion Inflation can affect an investor's investments, both in the short and long run. Inflation can erode the value of your investments over time, so it's essential to be mindful of how it can affect your portfolio.

By understanding how inflation works, you can make adjustments to your investment strategy to ensure that you're able to protect your investments from its effects.

Investors can invest in suitable asset, such as bonds (know how to invest in bonds online), classes according to their risk appetite and goals to beat inflation.

Check also- How Inflation Affects Your Investments, investment options