Protect your investments from the inflation demon

Why not deposits

In order to restrain inflationary pressures,the central bank hikes interest rates. As a result,depositors enjoy higher interest rates on their fixed term deposits. But here lies a catch. Inflation reduces the real value of your money. For example,say a food item cost you Rs 100 in 2009. Assuming an average food price inflation of 10%,this item will cost you Rs 110 today. Thus,though your expenses are still the same,you are spending more.In effect,your fixed deposit rate (x) should be more than inflation (y) to effectively beat the 10% price increase. Therefore,your real or actual return (x-y) should match or exceed the ‘inflated’ cost of living,which is often not the case.

Over a period of time,wealth creation is an eventuality and concern,not just to surpass the price effect but also to support your lifestyle,particularly after retirement. If one starts to invest early in life,the power of compounding would help you grow your net worth sizably. Even if you haven’t started yet,a disciplined approach and regular investing will bring handsome gains.

New Pension System

Today’s generation wants to retire early,but has limited or no post employment pension. Building an adequate corpus to take care of a comfortable livelihood after retirement is important. Moreover,because inflation erodes the corpus value,an extremely cheap annuity plan like NPS is a viable option.

Diversify into equity

As proven by past market cycles,despite the fluctuations in the short term,returns generated from equities supersede other asset classes in the long term. Thus,the portfolio strategy to beat inflation is significantly aided by allocation to equities. Also,it is better to have a diversified portfolio of stocks or invest in a diversified equity fund without a sector or industry bias. Sectors such as real estate,infrastructure and power,which require huge liquidity to supplement their long gestation plans,are greatly affected. Despite this,there are sectors which source raw materials such as grain and industrial metals,and offer essentials like utilities and medicines and these will continue to function in the same way. In fact,companies that produce these primary goods would benefit from the price rise.

Commodity investing

Investing in agriculture-based funds is another option. There are also commodity funds which invest in companies related to precious metals (read gold),energy stocks,metal and mining industry. Commodity prices are highly cyclical and subject to macro-economic and geo-political policies and consumption demands. In case of global commodity-based funds,currency risk is also applicable. However,aggressive investors can include these funds in their supplementary portfolio.

Gold — traditional hedge

Indians have a significant allocation to gold,albeit in jewellery form. With the emergence of ETFs and gold feeder funds,people are gradually looking at the yellow metal for investment. It also serves as a hedging tool during uncertain times. Currently,the steep rise in gold prices is owing to the slow recovery in developed markets. However,one has to bear in mind that gold does not generate interest income or pay dividends,so it is more of the appreciation in value that would actually benefit your portfolio.

* The writer is managing director,iFAST Financial; with inputs from Dhanashri Rane