Inflation: Today’s evil that needs to be won over

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Did you know that the Harry Potter universe has a creature called Niffler, who is attracted to shiny objects? Essentially, it steals your valuables and leaves you bereft.

There is also the Chinese winged lion-like mythical creature Pixiu who is known to eat gold and silver.
Do Savor

In real life, too, there is an abstract evil that likes to eat into our hard-earned money — inflation. Let’s understand what it is and look at the investment avenues that have the potential to curb inflation.

The inevitable evil called inflation

A persistent increase in the general prices of goods and services over a time period is known as inflation. Simply put, inflation erodes into your money’s purchasing power. However, this evil is also necessary. An inflation of 2–3% is actually beneficial to the economy and is, thus, inevitable.

Explaining inflation

Say, you made a fixed deposit of Rs 10,000 for a year at an interest rate of 10%. You would stand to receive Rs 11,000 next year. That seems an attractive proposition on the surface. But, a closer inspection may prove other otherwise if the price of products increased by 11%. This is because the item costing Rs 10,000 now would cost Rs 11,100 next year. Therefore, even though you earned a substantial amount from your fixed deposit, you wouldn’t be able to afford the same item now.

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The difference between inflation and the returns you earn is known as the real rate of returns. In true sense, real rate of returns is what needs to be in the green.

Investments that can beat inflation

Let’s assume you kept money stashed away in your locker a decade back. That money wouldn’t give you returns. Instead, inflation would’ve eroded its buying power. This is quite similar to what happens to your money in your savings account. That’s because a savings account grows at a modest 3-4% every year. Money in your savings account would give you negative rate of returns if the inflation rate is higher.

You could instead invest in avenues that have the potential to combat the effects of inflation and help in wealth creation. Let’s look at a few such investments:

  • Stocks and equity

Investing in stock markets is, though on a rise, still quite low in India. Equity is one such avenue that has the potential to counter inflation and give positive rate of returns. On October 31, 2017, the one-year returns for S&P BSE Sensex stood at 18.7%, while the one-year returns for Nifty 50 were at 19.47%. The inflation for the same period was at 3.58%. Thus, the real rate of returns were at 15.12% and 15.89% for S&P BSE Sensex and Nifty 50, respectively. However, you must exercise caution because stocks have a reputation for being volatile.

  • Mutual Funds

Mutual funds invest in various financial instruments. Most fund houses strive to outperform the price of the asset class they track. Their endeavor usually helps yield higher returns eventually.

They are also considered safer than stocks because they spread their investments across several sectors of the economy. Diversification helps reduce risk as different assets respond differently to economic swings.

The category-wise one-year returns for mutual funds and the real rate of return are as listed below:

Mutual fund types 1-year category average returns Real rate of return
Equity mutual funds 15.31% 12.03%
Debt mutual funds 7.61% 4.33%
Hybrid/Balanced mutual funds 13.45% 10.17%
Liquid mutual funds 6.65% 3.37%
Monthly income plan mutual funds 9.16% 5.88%

*The inflation for September 2017 was 3.28%

  • Public Provident Fund

Public provident fund (PPF) is another investment option that has the potential to counter inflation. The interest rates for PPF for the financial year 2017-18 was at 8.1%. The inflation for the same year was at 3.81%. Thus, the real rate of return stood at 4.29%.

Bottom line

Inflation may be an intangible concept but its effect can be telling. This is why it is important to invest in avenues that have the potential to beat the invisible force.

Investing instruments like mutual funds have historically proven to be a good ally in thwarting the negative effects of inflation. So, why wait to start investing in them.