By P Saravanan
SUPPLY CHAIN DISRUPTION due to the pandemic and geopolitical tensions have led to shortages of many commodities, driving up prices and fueling inflation. When the prices of goods and services increase over time, investors have questions about their future spending and consumption and whether the income/savings can meet their future needs. With inflation rates rising, now is a good time to understand what inflation is and how to create a portfolio to beat it.
What is Inflation?
Inflation is nothing but a measure of the purchasing power of a currency relative to a basket of goods. For example, let’s say that in 2012, with Rs 60, a person was able to buy a basket of goods consisting of consumer goods, and in 2022, the price of this same basket of goods is Rs 120. Then, we can say that the rate of inflation has doubled over a period of 10 years. Generally, inflation is measured as a rate of increase in the consumer price index (CPI) rather than the wholesale price index (WPI), since the former is a better indicator of reality in with regard to the increase in the prices of goods consumed by individuals. in all strata of society.
Asset classes that help fight inflation
In order to have a good investment portfolio that can beat inflation, the first strategy is to invest in assets whose ROI (return on investment) is higher than the rate of inflation. There are different asset classes that are good avenues for investments. Classic asset classes such as real estate, gold, etc. are considered inflation-proof investments.
But given the uncertainty in the economy, you have to be very careful even in those asset classes that are traditionally considered inflation resistant. For example, the real estate sector is often prone to manipulation by informal brokers and sometimes fails to yield expected returns if invested in undemanding geographic terrain. Instead, one could consider investing in selected Real Estate Investment Trusts (REITS). By investing in these REITs, investors could even participate in commercial real estate investments.
Gold for diversification
While gold has remained the most promising form of investment, in the recent past there have been issues related to the availability of the precious metal. Also, the government is now seeking to reduce the physical demand for this metal by encouraging other forms of investment in gold. For example, the Indian government is actively promoting sovereign gold bonds in which the securities are denominated in units of gold. These gold sovereign bonds could be seen as an alternative to investing in physical gold and are backed by the government.
In addition to the above two assets, most retail investors prefer to park their excess money in fixed deposits as a savior for their future. But investors should preferably not consider term deposits as an avenue of investment, given the inflationary trend and interest rates. Consider other asset classes like mutual funds, exchange-traded funds, and even stocks.
When it comes to investing in these asset classes, it is best to opt for a long-term investment strategy; say, about five years. In such a case, the return on investments will most likely be higher than inflation rates, thus achieving the desired goal of beating the inflation rate. In addition to investing in the aforementioned asset classes, investors may also consider diversifying their investment choices in order to diversify their portfolio holdings and thereby reduce associated market risks, apart from that of rising interest rates. ‘inflation.
In conclusion, investors should develop their own strategy based on their risk appetite since the ultimate goal is to beat inflation. Thus, investors might consider investing in any of the assets mentioned above, depending on their investment objectives.
(The author is professor of finance and accounting at IIM Tiruchirappalli. With contributions from A Paul Williams, researcher at IIM Tiruchirappalli)