How to invest during inflation?

Inflation refers to the rise in prices over a specific period. It’s generally a broad concept, reflecting either the overall increase in prices or the higher cost of living within a country. Investors often find it difficult to navigate inflationary pressures due to money's diminishing purchasing power. However, inflation can be tackled by adopting sound financial strategies, such as investing in company stocks of firms selling essential goods and services or buying inflation-adjusted government bonds.

These investments tend to perform better than others, preserving money's purchasing power. This article focuses on how to invest during inflation, highlighting the strategies and asset classes investors can choose to combat the effects of inflation on their investments.

What causes inflation?

Inflation is the gradual rise in the prices of goods and services, which decreases the purchasing power of money. In other words, the same goods and services now cost more than they did before. Inflation occurs when there are imbalances in the demand and supply sides of the economy. Inflation can be due to an abnormally high demand for goods and services. When demand remains constant, inflationary pressure can also rise due to the low supply of goods and services. A rise in the cost of inputs can force firms to reduce production, thereby impacting aggregate supply in the economy and pushing up prices. Supply shortages may also be caused due to supply chain disruptions.

Should you invest during inflation instead of just saving?

Most investors are puzzled by the question of how to invest during inflation to maintain good returns. Given the financially uncertain climate, some may feel that it's better to save funds than invest. However, experts suggest that you do not have to delay investments until inflationary pressures are curbed. Understanding how to invest during inflation and which instruments to rely on can help you invest wisely.

Learning how to invest during high inflation is significant because simply saving funds does not protect your purchasing power. Inflation erodes the purchasing power of saved funds. This means you must invest the funds in inflation-beating instruments to shield their purchasing power. Inflation-beating investments are investments whose returns exceed the average rate of inflation. The goal of investing during inflation is to outpace the average rate of inflation in the long term, and certain types of investment instruments can help you achieve this goal.

How to invest during times of high inflation?

Here are a few key pointers on how to invest during high inflation:

1. Real returns matter

Remember to factor in not just nominal returns but real returns from the investment when investing during inflation. Real returns refer to the actual amount of money you have left after factoring in the rate of inflation. It is also known as inflation-adjusted returns. Let’s assume your investment delivers a 6% return, and the current inflation rate is 4%. In this case, the real return from the investment is 2%, which means the purchasing power of your investment is growing at a 2% rate. However, if the inflation rate was 7%, then the real returns on your investment would be -1%. In other words, you would be losing 1% of the purchasing power of your investment. Therefore, it is essential to calculate the real returns on your investment when undertaking financial planning under inflationary pressures.

2. Equities for beating inflation

Most Indian investors tend to turn to FDs for investment due to the capital protection feature of time deposits. However, FDs rarely deliver inflation-beating returns and, therefore, may not be the wisest option during inflation. Conversely, equities have demonstrated a good track record of delivering positive real returns over the last few decades. While equity investments can be risky in the short term due to market volatility pressures, they tend to perform well in the long run. You can start investing in equities with SIP investments to build a disciplined and regular investment habit and long-term inflation-beating wealth.

3. Enhance your portfolio

Seasoned investors and market experts consider gold as a safe asset that’s the perfect hedge against inflation. For decades, gold has served as a store of value, generally performing well under inflationary pressures. Gold is also priced in US dollars and converted into the Indian Rupee each time you buy or sell gold in India. This helps directly hedge against depreciation in the value of the Indian Rupee. When adding gold to your portfolio, you can consider Gold ETFs, Sovereign Gold Bonds, and Gold Fund of Fund (FOF), instead of physical gold.

4. Preparing for your future

For optimised investment success, taking a long-term perspective is essential. Just because inflationary pressures are low today does not mean such low inflation rates will persist in the future. Therefore, it is important to be proactive and curate a portfolio that allows you to stay prepared for the future. Adding the right investments, calculating real returns, and investing wisely can help you do that. Investors generally feel anxious when inflation rates go up. For instance, when portfolio value rises, you may want to take the profits and exit. Similarly, when prices fall, selling and avoiding losses may be tempting. The key at such times is to focus on the long-term perspective and refrain from making impulse decisions that compromise your returns.

5. Review your portfolio

Learning how to invest during inflation is not enough for investors. They must also regularly monitor their portfolios to maintain the right asset mix. An optimised asset mix can help you grow your wealth over time and minimise short-term risks. Therefore, you need to rebalance your portfolio to ensure it aligns with your original asset allocation target. To do so, you can seek the help of a professional financial advisor who can carefully evaluate your risk appetite and financial objectives before rebalancing your portfolio.

Where to invest during high inflation?

Now that we’ve covered how to invest during high inflation, it's time to understand where you should invest your funds when inflation rates are soaring. The following asset categories are deemed few of the best options for investors aiming to build a portfolio that beats inflation in the long run:

1. Stocks

Investment in company stocks has historically yielded inflation-beating annualised returns. For instance, the Nifty large-cap index delivered an annualised return of 10.9% over the last 10 years. Let's assume inflation rates remain above average at 4% every year, and your stock investments perform below par, generating annual returns of 8%. Even in such cases, your returns are double the inflation rate, indicating corpus growth rather than losses due to inflation. If you’re a low or medium-risk investor, averse to the short-term volatility of equities, you can invest in stocks through mutual funds. Mutual funds invest in a diversified portfolio of stocks, bonds, and other assets, offering exposure to a broad range of assets without requiring you to pick individual stocks.

2. Inflation-protected bonds

Apart from equity investments, you can also invest in select bond categories to protect your investment against devaluation. Central banks generally raise the interest rates in an economy to combat rising inflation levels. Such rising interest rates can be detrimental to bond prices. However, investing in Inflation Indexed Bonds or IIBs can be a good way to hedge against such pressures. Issued by the Indian Government, IIBs are fixed-income securities that offer inflation protection to both your principal and interest payments. These bonds offer inflation-adjusted returns on your investment, meaning your returns are protected against devaluation due to inflation. The return rate is determined by indexing for inflation using the CPI or Consumer Price Index.

3. Real estate

Real estate is another good asset to add to your portfolio as a hedge against inflation. Generally, property value and rental incomes rise during inflation, making real estate a prudent asset. You can choose to invest in real estate directly by buying properties, or you can invest in this asset through real estate investment trusts (REITs). REITs are companies and corporations that own and manage a portfolio of income-producing properties. You can buy shares in a REIT listed on the NSE or invest in REITs through mutual funds or ETFs.

4. Gold

As mentioned earlier, the yellow metal is one of the safest and most common inflationary hedges investors have relied on for centuries. You can add gold to your portfolio in various ways, including gold ETFs and mutual funds. You can also invest in gold through tax-free Sovereign Gold Bonds, which the Government of India issues against grams of gold, and returns are based on the market value of gold. These investment routes are generally preferred over holding physical gold or buying bullion since they eliminate the need to hold physical gold.

5. Consumer staples

Also known as defensive stocks, consumer staples offer a unique hedging opportunity against inflationary pressures. Consumer staple companies are firms that manufacture, supply, and distribute essential consumer goods that people require regardless of the economic conditions. Stocks of these companies face limited volatility even during high inflation levels simply because the demand for their products remains more or less constant. In other words, these stocks perform more consistently during inflation than stocks of companies selling non-essential products.

Mutual funds: Inflation-indexed funds

Judicious mutual fund investments can also help minimise the impact of inflation on your portfolio. For effective inflation hedging, you can invest in inflation-indexed mutual fund schemes. These are primarily debt mutual fund schemes that invest in inflation-indexed bonds to ensure capital appreciation that’s indexed to inflation.

How to combat the impact of inflation on mutual funds?

You can implement the following measures to ensure your mutual fund investments are well-protected against rising inflation rates:

1. Optimum diversification

Diversification is one of the key strategies that can help minimise the impact of inflation on your portfolio. Spreading your MF investments across different types of funds like equity, debt, and hybrid funds can minimise the impact of inflation, keeping returns relatively stable and risks low. This is because different underlying asset classes respond differently to inflation.

2. Regularly review and make adjustments

As already mentioned, periodically reviewing and rebalancing your portfolio is crucial when tackling inflation. For instance, if interest rates have remained high for a prolonged period due to high inflationary pressures, you can consider reducing your non-inflation-indexed debt exposure. To do so, you have to remain vigilant to market trends and inflation levels and frequently review and adjust your portfolio.

Explore these related articles to deepen your understanding and make informed investment decisions:

• What are solution-oriented mutual funds

• SIP guide

• What is mutual fund overlap

• What is a total expense ratio

• What is a small-cap mutual fund

Key Takeaways

• Identifying the right inflation-beating assets is the key to understanding how to invest during inflation.

• Several assets like equity stocks, gold, real estate, and inflation-indexed mutual funds have proven to be good inflation hedges.

• Investing in inflationary hedges allows investors to safeguard the purchasing power of their investments.

There is no way to keep business cycles at bay, which means inflation and recession are part and parcel of investing. Therefore, learning how to invest during inflation and recession is one of the cornerstones of investment education. Investing during inflation is all about devising the right strategies that work for you. Managing your portfolio during inflation can be challenging, but it is not impossible. The core of understanding how to invest during inflation is identifying the right assets and maintaining an optimised balance. Doing so can help you protect the purchasing power of your money from the devaluing effects of inflation.

Investing in mutual funds can be a great way to build long-term wealth with inflation-beating returns. You can curate a diversified MF portfolio on the Bajaj Finserv Mutual Fund Platform after comparing 1000+ mutual funds. Depending on your investment style and convenience, you can choose to invest with SIPs or a lump-sum deposit. You can even estimate returns for different goals and time durations using our free mutual fund calculator.

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