A recent joke about inflation runs like this – “Gas prices are so high...That even the Coronavirus has stopped travelling.” Well, while this may be on a lighter vein, the underlying cause inflation is not really a laughing matter.
However, with some wise financial planning and application of mind we may just be able to run ahead of this economic form of Coronavirus.
“Yes, indeed inflation is just like a hidden 'tax' that erodes our savings over time,” says Aniruddha Bose, Chief Business Officer, FinEdge.
Regrettably, most people tend to adopt the "ostrich in the sand" approach when it comes to inflation, somehow believing it will go away if we ignore it.
It will not! You will probably need a lot more than you think to fund your retirement or pay for your child's higher studies - and so not taking risks and earning negative real returns is, ironically, the biggest risk of all.
Do remember that you may face the woes of inflation being more than your savings rate. India’s inflation rate stood at 6.44 percent as of February 2023.
However there is a silver lining on the dark (inflationary) cloud – equities. You, Dear Informed Investor, may consider investing in equities to gallop ahead of inflation. Experts advise that this may be possible as opposed to fiction.
“History tells us that equity beats inflation consistently over long periods,” says Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.
He does add the caveat that this has to be over a sustained timeframe and not a one-off. If we take the last one year, Sensex return has lagged behind inflation. But if we take the last 5, 10, 15, 20, 25, 30-year periods, Sensex has consistently beaten inflation.
“Equity has one of the best potentials to beat inflation in the long run,” says Shrikanth Subramanian, CEO – Kotak Cherry.
Looking at the last 11 years' data since 1st Jan 2012, the Indian market (Nifty 50) has delivered over 14% CAGR returns. Cost of an article which could have been bought at ₹100 would cost ₹188 in 2022, rising at an annual rate of around 6%. The same ₹100 invested in Nifty in 2012 would have become ₹445, as an illustration of how equities are a possible antidote to the inflation virus.
Subramanian too adds the caveat that this has to be on a 5-10 year horizon basis rather than a timeframe more transient.
So far, so good. But how do we go about this practically?
“First, do not invest in an ad hoc manner,” says Bose. Instead, align your equity investments to clearly defined financial goals. This simple act will broaden your investing outlook and help you fixate less on short term market fluctuations and more on the big picture. This will automatically eliminate a lot of the behavioural pitfalls.
Second, acquire a thorough understanding of the interplay of risk and reward. You must know what to expect while investing in equities, as the inflation beating returns come at the cost of significant volatility. It’s going to be a bumpy but rewarding ride, and in order to benefit, you have to be prepared to see your capital in the red for extended phases without jumping the gun and succumbing to the action bias. Investing with awareness of what lies ahead is absolutely critical!
Finally, do not look at your portfolio too often. An extreme case in point is the story of a senior mutual fund executive who recently toured the country meeting the longest standing investors in their flagship blue chip fund that had returned nearly 20% CAGR over three decades. When quizzed on their "success formula" for being able to hold on through so many ups and downs, almost all of them admitted that they had "forgotten" about the investment!
While this is an extreme example - and an annual review of your goals and portfolio with an advisor is warranted, it does effectively illustrate the importance of not obsessing much about day-to-day market returns if you want to reap the benefits of equity investing.
So, the key takeaway is that you need to know yourself (your investment priorities) before investing in equities.
Next, experts feel that retail investors though able to use equities to beat inflation, may not be able to make the value calls needed to navigate the shoals of the equity ocean.
“This is not going to be a one size fits all market,” says Subramanian. You have to cherry pick stocks that you can invest in. This means going through financial data to get a better understanding of what the company does, how sound the financials are, how leveraged the company is, see track record of the management, how the company has done vis-a-vis its peers in the industry, various key ratios (Price/Earning, Price/Book, etc.), etc.
But can such due diligence be done by small investors busy in their routine chores of home and hearth?
“I suggest that they (investors) can invest through ETFs or through SIPs in equity/hybrid mutual funds,” says Vijayakumar.
Direct equity investing typically tends to bring about a speculative mindset, partly due to the reasons for investing in the first place (suggestions from friends or brokers, chasing the next multi-bagger, tips from TV market pundits, etc.) and partly due to the high degree of sensationalism of stock market movements by the media. It becomes so difficult to invest with a cool mind with all that noise clouding your judgment! “SIPs that are aligned to clear goals offer a much more dispassionate and 'solid' alternative,” say experts.
“We are of the view that equities remain the most time tested and efficient mechanism for beating inflation with your savings, if you can manage the behavioural side of investing into them,” says Bose.
Other options to beat inflation
Real estate and gold have sometimes been suggested as inflation beating investments, alongside equities.
“However, Gold is really an ‘inflation matching’ investment at best over the long run, and is more relevant as a risk hedge during economic crises than as a long term inflation beating investment,” says Bose.
Real estate is quite hit or miss; while more sophisticated investors have been able to beat inflation in this asset class by spotting trends ahead of time or by buying distressed assets and holding on to them, most retail investors who have leveraged themselves to buy property have probably not beaten inflation net of transaction charges, interest expenses, and other associated ancillaries like the costs associated with maintaining the property.
Time and budget
Suppose an investor had a budget of ₹10 lakh. We asked the experts on their advice to the investor in managing his/her funds in the inflation battle.
It depends on your time horizon and investment goals. If you need the money within 6 months, say for a down payment on a car or a wedding or education, look at fixed deposits. If you are looking at 6 months to a year, equity savings schemes might be a good bet. These schemes use the power of arbitrage very well. “The money you should put into pure equities is money you need after 3 years,” says Subramanian.
“Investment in equity should be goal-oriented," says Dr. V K Vijayakumar. For example, youngsters in their twenties or early thirties can invest up to 70 percent of their investible funds in equity, provided they have a minimum investment horizon of 4 years.
“It's an unfortunate fact that most investors do not go on to earn inflation beating returns from their equity investments,” says Bose.
This phenomenon is called the 'behavior gap' in investing, and it tends to come about because equity returns are nonlinear - and hence investors consistently and predictably keep falling prey to their emotions while investing.
Examples include trying to time the market by buying low and selling high, fence sitting, stopping their SIPs during market crashes, etc. As a result, they rarely end up earning the actual published returns from the stocks or mutual funds they buy into, which is unfortunate but avoidable.
Manik Kumar Malakar is a personal finance writer.