Why traditional investments can't bail you out of inflation?

There is no sure-shot way to protect your investments from the rising inflation. India’s retail inflation for the month of July, as measured by the Consumer Price Index (CPI), is at 5.59%. Subsequently, the Reserve Bank of India (RBI) increased the CPI forecast from 5.1% to 5.7% for FY22. Before starting any new investment for a specific financial goal, one must factor in the impact of inflation to plan a better strategy for reaching that goal. What you assume is ‘enough’ today may not be the case a decade from now. This is especially relevant for those planning a retirement corpus or saving for kids’ higher education.

“Inflation reduces the buying power of money, thus the return one should look for on their investments is one which is higher than inflation so that your purchasing power doesn’t diminish. However, inflation generally is close to or higher than the risk-free rate. Thus one has to have a decent quantum of the portfolio in riskier assets where the risk-adjusted return given a good cushion above the inflation rate,” said market veteran Ambareesh Baliga.

To overcome inflation successfully, one should focus on real returns from their investments. The real return is what you finally get in your hands after adjusted for inflation. For example, if you earn 10% return on an investment where you pay 30% as tax and inflation is 5% – then you end up earning a real return of 2%. As a result, traditional investments like fixed deposits (FDs) have not kept pace with inflation.

“Fixed Deposits (FDs) normally have been destroyers of purchasing power though it’s the most popular form of savings and investment for a large portion of the investing population. One should invest across various asset classes so that there is diversification of risk. However, it’s pertinent for the investor to understand the risks of each of these asset classes before investing,” Baliga advised.

Generally, the risk-free investments like India FDs with PSU Banks will be at an inflation rate or lower unless it’s a deflationary scenario.

Assess your risk appetite, tolerance, and financial capacity before indulging in any kind of investment. For example, when you begin your mutual fund journey, you may be in for some shock in a way that a trick/tip that has worked for others may not work for you specifically. Why? Because each investor has a different risk appetite and nature to respond to market activity. Your capacity to take a financial risk will depend on so many personal factors like your savings, liabilities, etc. Hence there is no one solution for all.

Similarly, you have to find a different path to make your investments inflation-proof. Have a diverse portfolio and invest as per your financial goals. Be well-acquainted with your finances, of course.  However, one common tip that does work for all is to start early. When you begin investing at an early age, you’ll reach your goals faster. This will give you flexibility and more options to explore.