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How Inflation Destroys Your Investments?

IndianMoney.com Research Team | Posted On Monday, December 16,2019, 02:34 PM

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How Inflation Destroys Your Investments?

 

 

The tax season is weeks away and people are busy with tax planning. So why tax planning? Well, every rupee saved in taxes is a rupee earned. Sadly, no one focuses on the silent investment killer called inflation. It reduces purchasing power which is the amount of goods and services purchased with a unit of currency (Rupee).

The first goal of investing? Make sure your money grows faster than inflation. Inflation-proofing keeps your money safe from inflation and maintains purchasing power. If you don’t pay close attention to inflation while investing, you are going to get poorer and not richer.

In India CPI Inflation climbed from 4.6% in October 2019 to 5.5% in November 2019. With onion prices soaring, this was bound to happen. Now, with inflation so high, let’s see what happens to your investments.

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How Inflation Destroys Your Investments?

When it comes to investments, the buzz word is the real rate of return. What is the real rate of return? It’s nothing but returns after inflation. Let’s get an idea of how to calculate the real rate of return.

Real Rate of Return:

Real rate of return = 1 + Nominal Rate      -  1

                                                                1 + Inflation Rate

You plan to invest Rs 10,000 in a good financial instrument. Assume inflation rate of 6% and a time period of 20 years. You need a figure of Rs 32,071 to enjoy the same purchasing power as your Rs 10,000 today. (Hint: Use the Future Value Formula)

Now, where to invest that Rs 10,000? Leave it in the savings bank account or invest in FDs or put it in equity mutual funds.

Instrument Invested

Future Value (Rs)

Savings Bank Account (3%)

18,061

Fixed Deposits   (7%)

38,697

Equity Mutual Fund  (15%)

1,63,665

You require an amount of Rs 32,071 to maintain the purchasing power of your money. If you look at the FD returns, there isn’t much left over 20 years. After-tax and inflation, you get almost nothing.

The real rate of return = 1 + 0.07 / 1+0.06 – 1

= 0.95%. The FD investment is actually yielding just 1% before tax over 20 years. This is the real value of your investment. Almost nothing Right?

See Also: Types Of Investment Plans

How to Get Inflation-Beating Returns?

Check Returns from Conservative Investments:

Have a look at popular conservative investments like FDs, PPF, NSC or SCSS. The fixed deposits give 7%, PPF and NSC give 7.9% and SCSS gives 8.6%. With inflation at 6%, the real rate of return of these instruments is closer to 2%. These may be low risk investments, but their returns aren’t too great either.

It’s vital to have conservative investments like PPF or NSC in the portfolio. In spite of the lock-in of 5 years in the case of NSC or 15 years for PPF, they protect your portfolio when stock markets crash.

Have Gold in the Portfolio

Gold is often considered to be a hedge against inflation. Start an SIP or invest in gold ETFs regularly. Have at least 10-15% of your portfolio in gold for the sake of diversification.

Keep an eye on taxation of gold. The short term capital gains or STCG (This is if the investment is held for less than 3 years) is added to taxable salary and taxed as per tax slabs. The long term capital gains or LTCG (This is if the investment is held for more than 3 years) is taxed at 20% after indexation.

See Also: Best Investment Plans for 2019

Increase Exposure to Equity:

If past history is an example, inflation has been around 6-7%. Equities give around 8-12% returns, while high returns of 15-20% are possible. This is around 4-7% post tax and inflation. So, a real return of 5-7% is quite good, making an investment in equity mutual funds, really important.

Invest in equity with a time horizon of 5 years or more. This helps achieve financial goals well within time.

How Many Allocations to Equity?

Use the thumb rule of 100 – age for equity allocation. A 35 year old must have 100 - 35 = 65% in equity.

See Also: A Five-Minute Guide to the Systematic Investment Plan

How Much Money Do You Need for Retirement?

Most people are happy with a retirement corpus of Rs 1 Crore. Well, if you are 35, you will need Rs 4 Crore at retirement. (This would be the value of Rs 1 Crore when you are 60 years about 20 years from now if inflation is 6%). Well, how to get this money?

How much to invest in equity via SIPs to get this retirement corpus? A monthly investment of Rs 70,000 in equity mutual funds through SIPs with expected annual returns of 8% can give retirement corpus of Rs 4 Crores. (Use IndianMoney Investment Calculator to do the calculation).

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