The purse of happiness

Saikat Neogi Posted online: Tuesday, Jun 03, 2014 at 0000 hrs
As inflation trends up after a brief pause, investors not only need to take adequate steps to protect financial assets, but also need to be careful about future investments and review their existing investments periodically. Sticky inflation reduces one's purchasing power, dragging the value of one's savings over the long run.

The best way to deal with inflation is to choose an investment portfolio that helps to counter inflation and generates higher returns. One must look at allocating funds in equity, debt, gold and real estate to generate higher long-term returns.

When prices in the system are on an upward spiral due to persistent demand, the RBI aims to reduce demand in the economy by raising the cost of money. A recent note from Citibank says that while the overwhelming election mandate has energised equity and currency markets, the fears of elevated inflation/higher borrowing have resulted in the rates market remaining lacklustre. The bank is of the view that CPI will average 8% in FY14 and 6.5% in FY16.

In fact, hailstorms in March had driven up food prices and pushed CPI to 8.6% in April. More worrying was food price inflation, which rose to 9.8% in April from 9.2% in March. Core inflation remained steady at 7.9% year-on-year. The inflationary impact can still be countered if the government takes adequate measures, such as large-scale disbursement of grains from stocks, addressing supply-side bottlenecks and cracking down on hoarders.

The real dampener is the IMD's prediction that rainfall will be 5% below- normal this year. The department sees a 60% probability of sea temperatures reaching the El Nino threshold, which is associated with lower rains. If monsoon is 5% below normal, food output will be hit, which will affect the overall macro economy.

Previously, weak rains (10-15% below normal) have resulted in lower foodgrain output growth, zero-to-negative agriculture GDP growth and higher food price inflation.

Rising inflation can create havoc in your financial life, be it day-to-day expenses, retirement planning, children’s education, their marriage, vacation or medical expenses. In a rising inflation scenario, it makes sense for the retail investor to do some portfolio rebalancing.

Also, one needs to invest regularly. Hunt for higher fixed deposit rates offered by banks to park long-term funds. Take the mutual fund route to invest short- and medium-term funds after evaluating the fund's performance and charges. Inflation-indexed bonds offered by the government are also a good option as they protect the principal from inflation, delivering returns that nullify inflation. The principal amount of the bond is adjusted to reflect the inflation in the economy.

Over the long run, equities give better returns and help combat inflation. An experienced investor who understands the markets and has the time and knowledge to deal with volatility can consider investing directly in stocks. Analysts say it is important that a retail investor does his research well and owns a diversified portfolio of stocks (or invests in diversified equity funds). “Despite short-term cyclical fluctuations, returns generated from equities supersede those from other asset classes,” says Brijesh Damodaran, founder and managing partner at Zeus WealthWays LLP.

Sectors like pharma continue to be defensive, and companies that produce primary goods benefit from price rise. Even the IT sector remains unaffected from high inflation, and certain FMCG companies continue to post healthy results. As part of portfolio rebalancing, short-selling is a good way to ensure profit-booking when markets are volatile. In a volatile market, prices move too frequently and investors need to take some risk after consulting their broker or fund manager.

Analysts suggest that investments in commodities can be a good way to rebalance the portfolio. If an investor is not looking at investing directly in commodities, he can go for commodity funds that invest in companies related to gold and silver, energy stocks and metal and mining. However, there is a caveat: commodity prices are highly cyclical and subject to macroeconomic policies of the government and demand and supply.

Always a good hedge against inflation, gold has been a favourite of retail investors in India, though in the form of jewellery. However, since gold in physical form does not provide any interest income (unlike fixed deposits),and nor does it pay dividends (unlike equities), one has to wait for the metal to appreciate before selling it.

Real estate is an asset class that delivers returns in line with inflation. In inflationary periods, property prices move upwards and give good returns on sale. In such times, analysts say, retail investors must rebalance their portfolio every six months, factoring in the effects of taxation and exit loads.