Investing in the share market during an inflationary period can boost corporate profits, especially when companies pass on higher input costs to customers through price hikes. It also means that for investors it is more important than ever to start putting their long-term savings in the stock market.
One of the most effective ways to combat inflation is to maintain a well-diversified and fully invested portfolio. In the long run, money invested in stocks tends to outpace inflation, whereas positions in real estate, commodities, and so on can only serve as additional diversification. Cash on the sidelines will always lose value, while long-term bonds will suffer if interest rates begin to rise.
In the long run, investing in equities can prove to be a good way to outrun inflation. For example, the average annual return of NIFTY for 2021 is 24.12%, higher than the 6.71% annual inflation seen recently.
Investing in any securities having greater returns than the inflation rates can help the money grow rather than depreciating its value. Investments like stocks, FD, bonds can help in the short to medium terms whereas, gold and real estate can be for the long term.
Investing in precious metals can also add some diversification to your portfolio if it mainly consists of stocks and bonds. Gold is not the best option when it comes to short-term inflation but is sustainable during long-term inflation.
On the other hand, investing in commercial real estate during inflation not only protects you against inflation but also increases the value of your assets during inflation. The successful businesses during inflation are those that you purchase once and then don’t have to continue making capital investments afterwards, whereas you must prevent any business that necessitates a large capital investment.
During periods of inflation, value stocks outperform growth stocks. Shares with a higher intrinsic value than their current trading price are considered value stocks. They are typically shares of mature, well-established companies with strong current free cash flows that may decline over time.
Companies with high earnings relative to their current share price are considered value stocks. They are also known for having strong cash flows, which investors value when prices are rising. During inflationary periods, shares with higher current cash flows are more valuable than growth stocks with longer-term returns.
Inflation-indexed bonds and Treasury Inflation-Protected Securities (TIPS) tend to increase their returns with inflationary pressures hence, providing great investment options to long term investors. TIPS also pay fixed interest rates twice a year.
Hence, look for good businesses with low capital requirements and companies that raise prices during higher inflation periods, proactively structure your portfolio and include smart positions in asset classes that minimise the effects of inflation.
Have a flexible budget when building your portfolio so that inflation cannot dominate your portfolio design. It is always advised to have calculated moves in a volatile market as the risk exposure is higher than normal times. During times of inflation, always remember that the government takes measures against it, so have a foresighted investing structure ready.
(By Manoj Dalmia, Founder & Director at Proficient Equities)
Disclaimer: This is the author’s personal opinion. Readers are advised to consult their financial planner before making any investment.