Equity investment is considered as an asset class that can help to beat inflation over the long term.
One of the widely discussed topics in the last few days is the increase in prices of essential commodities.
The growing costs of everything we need and want are a harsh reality for most of us. We notice price increases every few months, and after a few minutes of moaning about the rising prices, we swallow it and go on.
However, these price increases over time have a significant impact on our purchasing power and the value of our money. The word used to describe this increase is inflation.
Simply said, inflation increases the overall level of prices for goods and services in a given economy.
What causes this increase in the cost of goods? It's just a simple supply-demand imbalance. The rise in the price of products is caused by "too much money chasing too few things." Our paper money or currency begins to lose value due to inflation.
Homes, groceries, medical treatment, utilities, and luxury items like cars and jewellery are all affected by inflation. People and businesses get worried when inflation rises, and it starts to spread across the economy.
Inflation is an issue because it reduces the value of money saved today. Inflation reduces a person's buying power and could even make it difficult to retire.
Impact of inflation on savings
In addition to the effect of inflation on the purchasing power, it also impacts your savings. Let us consider an example. Suppose you have deposited Rs. 10,000 in your savings account that gives you a 4% interest rate. After a year, you will have Rs.10,400 in your savings account. However, if the inflation rate is 6%, you will need Rs. 10,600 to have the same purchasing power as last year.
So, we have seen that although you had Rs.400 in one year, your purchasing power is worse off than it was last year.
Inflation eating away your savings can hurt retirees living on the money accumulated throughout their working life. Inflation doesn't just hurt retirees. It can also affect reaching your other financial goals, such as a child's higher education.
How to protect your savings from the inflation demon
One way to protect your savings from inflation is to invest your savings in an option that can give you a higher rate of return than inflation. The real rate of return of an investment option is the return that it generates after subtracting the inflation rate.
However, it is essential to consider your risk tolerance and investment horizon before selecting an investment option.
Equity investments are generally considered one of the best asset classes to beat inflation over the long run. However, equities are very volatile in the short run, and it may not be everyone's cup of tea. So, investment in equities through a mutual fund is a better option for individuals who can't handle the ups and downs that comes with direct equity investment. Fund managers manage equity mutual funds and take investment calls after adequate research. As a result, investors don't have to worry about the day-to-day market movement.
Moreover, a passive investment strategy where an index is replicated is another strategy that individuals who do not want to depend on the fund manager's expertise can take. Exchange Traded Funds (ETF) or index funds are two ways to invest in an index with minimal cost.
While equity investments are a better option for individuals who can take a risk and have a longer time horizon, where should investors with low-risk tolerance invest in safeguarding their savings from inflation?
A debt mutual fund is one investment option for investors who are not comfortable with the volatility of equity investments. Debt mutual funds invest in debt instruments, and it aims to protect your money and provide returns that can beat inflation. Moreover, you can benefit from indexation if you stay invested in debt funds for more than three years. Indexation considers the impact of inflation on the overall investment gains. As a result, gains above the inflation rate are considered for taxation purposes.
Investing in gold or silver through ETFs and funds can also aid in saving hard-earned money from inflation. A personalised asset allocation plan that helps generate wealth and protect your capital is the right way to invest in assets and safeguard your money from inflation.
We can't escape from inflation. The best way to tackle inflation and protect the value of our money from getting eroded is by investing in investment options that will grow your money higher than the rate of inflation.
Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.