At this point of time, even though the headline numbers may not be suggesting very high inflation, it is very much there and has started hitting the spending capacity of everyone around.
Look around, Bank FDs, Liquid funds, other debt mutual funds, etc. most of them are delivering returns in the range of 3-5%. Consumer inflation is now running at a rate of 7.5% while the actual rate of inflation for most of us is much higher.
Unfortunately, for savers, it will be almost impossible for them to earn more than the rate of inflation if they continue to stick to very safe fixed income investment options.
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It is what we call as negative real interest rates scenario. You earn something like 4-5% on your investments while the inflation rate 7-9% and thereby the real value of your money is actually going down.
How long is high inflation going to last?
Frankly speaking, we don’t know; however, looking at the huge quantity of money poured into the economy (in response to Covid-19) over the last few years, it doesn’t seem like inflation is going to cool down very soon.
One factory that is favourable though is that some part of the inflation is also on account of extraordinary supply and demand imbalances created by the pandemic which may eventually normalize.
However, because the events of the past 18 months have been so extraordinary, we simply don’t know how long these supply and demand imbalances will last.
With inflation remaining a risk, as a saver and an investor, what are your options?
Well, the answer is, you will need stocks/equity in your portfolio.
Just to be clear, we believe you should always maintain 6-12 months emergency fund in safer options like Bank FDs, liquid funds, etc.
However, for any surplus which you think you won’t need for 3-4 years, you should definitely consider stocks for your investment portfolio.
To appreciate this, it’s important to understand the source of profits for the companies.
In theory, a company's revenues and profits should grow with inflation after a period of adjustment. This is especially true for companies with high operating leverage.
What is important though is that you shouldn’t lose sight of the valuations because growth stocks at very high valuations are negatively impacted far more than value stocks in times of rising interest rates.
What about volatility?
One of the concerns investors have about equities is volatility.
Well, the best way to address the same is to cut the daily news and stop watching markets and your portfolio on daily basis. You don’t look at the price of your house or other real estate investments on daily basis.
Also, as mentioned above, invest only that surplus which you think you can easily invest for the next 3-4 years. Volatility impacts you much more when your horizon is say a few days to few months.
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