Persistently high inflation has emerged as a key concern for investors. Consumer price inflation in India remained above the RBI’s comfort zone for several months. When prices rise faster than expected, it erodes purchasing power and hurts fixed income investors. However, some smart portfolio adjustments can help counter the risks from inflation, while tools like an inflation rate calculator can help make necessary adjustments to preserve investors’ purchasing power.
Understanding inflation
Inflation refers to the sustained increase in the general price level of goods and services in an economy. It is measured through the consumer price index (CPI) which tracks a basket of household items on a monthly basis. Inflation typically arises when demand grows faster than supply or production costs increase.
High inflation hurts fixed income investors the most as the returns fail to keep pace with the rising prices. It also creates uncertainty over future costs and interest rates for investors across assets.
Use an inflation calculator
To assess the impact of inflation, investors should use an online inflation calculator. For example, if current inflation is 6% per annum, Rs 1 lakh of purchasing power will reduce to around Rs 94,000 in five years. Investors need returns higher than inflation just to preserve purchasing power.
Increase equity allocation
Equities have historically delivered inflation-beating returns over the long run. Stocks act as a hedge as corporate earnings tend to rise during inflation due to pricing power. Investors worried about inflation should increase their overall allocation to equity mutual funds through systematic investment plans (SIPs).
Prefer short duration debt funds
Long tenure bonds suffer the most in rising rate scenarios. Investors should switch from long duration funds to short duration or ultra short debt funds. The latter adjust to rate hikes more quickly as the underlying bond portfolio has shorter maturities. Short term funds help mitigate interest rate risk.
Add inflation-indexed bonds
Inflation-indexed bonds or Linkers offered by the RBI provide attractive inflation protection. The coupon and principal payments from these bonds are adjusted for inflation. When CPI rises, investors receive higher payouts. Targeted allocation to Linkers balances rate risks in debt funds.
Explore gold funds
Gold functions as an inflation hedge historically. Gold savings funds from mutual funds allow participation in gold price movements in a convenient form. Around 10-15% allocation to gold funds can offset equity and debt risks during high inflation.
Avoid cash pile-up
While cash provides liquidity, it gives negative real returns during inflation as the interest earned is negligible. Investors should limit cash to only emergency funds and deploy higher allocations to mutual funds through SIPs. Remaining 100% in cash can erode purchasing power quickly.
Monitor portfolio regularly
Review asset allocation more frequently during inflationary periods. As inflation moderates, reallocate back from equity to debt. Booster doses of equity during bouts of high inflation prevent cash holding erosion. Monitor mutual fund performance relative to categories and adjust laggards.
While inflation impacts personal finances, prudent investing can offset some of the downsides. Inflation-beating returns require rational investing backed by consistency, diversification and periodic reviews. Over long periods, equity and debt mutual funds along with tactical hedges like gold and linkers help create inflation-resistant wealth. To use inflation calculator click here.
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