By P Saravanan
SUPPLY CHAIN DISRUPTIONS due to the pandemic and the geopolitical tensions have led to scarcity of many commodities, pushing up prices and stoking inflation. When the prices of goods and services increase over time, investors have questions regarding their spending and consumption in the future and whether the income/savings can meet their future requirements. Given the rising inflation rates, it is the right time to understand what inflation is and how to create a portfolio to beat the same.
What is inflation?
Inflation is nothing but a measure of purchasing power of a currency with respect to a basket of goods. For example, let us say in the year 2012, with Rs 60, a person was able to buy a basket of goods consisting of consumer-centric goods, and in the year 2022, the price of that same basket of goods is Rs 120. Then, we can say that the inflation rate has doubled over a period of 10 years. Generally, inflation is measured as a rate of increase in the consumer price index (CPI) rather than the wholesale price index (WPI), since the former is a better indicator of the reality with respect to increase in the prices of goods consumed by individuals in every stratum of the society.
Asset classes which help to beat inflation
In order to have a good portfolio of investments that can beat inflation, the first and foremost strategy is to invest in those assets whose ROI (return on investment) is higher than the rate of inflation. There are different asset classes that are good avenues for investments. Conventional asset classes such as real estate, gold, etc., are seen as inflation-proof investments.
But given the uncertainty in the economy, one should be very careful even in such asset classes which are traditionally considered as inflation-proof. For instance, often the real estate sector is prone to manipulation by the informal brokers and at times, does not give due returns if invested in an un-demanding geographical terrain. Instead, one could consider investing in selected Real Estate Investment Trusts (REITS). By investing in such REITS investors could participate even in commercial real estate investments.
Gold for diversification
While gold has remained the most promising form of investment, in the recent past, there have been issues relating to the availability of the precious metal. Also, the government is now seeking to reduce the physical demand on this metal by promoting other forms of investments in gold. For instance, the government of India is actively promoting Sovereign Gold Bonds wherein the securities are denominated in units of gold. These Sovereign Gold Bonds could be considered as an alternative to investing in physical gold and it is backed by the government.
In addition to the above two assets, most retail investors prefer to park their surplus money in fixed deposits as a saviour for their future. But investors should preferably not consider fixed deposits as an avenue for investments, given the inflationary and interest rate trend. One should consider other asset classes like mutual funds, exchange traded funds and even equity shares.
When it comes to investing in these asset classes, it is best to go for a a long-term investment startegy; say, around five years. In such a case, the return on investments will most likely be above the inflation rates thereby achieving the desired goal of beating the inflation rate. In addition to investing in the above-mentioned asset classes, investors can also consider diversifying their investment choices so that it will diversify their portfolio holdings and thereby reduce the associated market risks apart from that from rising inflation rates.
To conclude, investors should come up with their own strategy based on their risk appetite since the ultimate desired goal is to beat inflation. Thus, investors could consider investing in any one or a combination of the above-mentioned assets, based on their investment goals.
(The writer is a professor of finance & accounting at IIM Tiruchirappalli. With inputs from A Paul Williams, research staff at IIM Tiruchirappalli)