It is quite understandable that not all investors are alike. Some are like the Virat Kohli's of the cricketing world, seeking to reap maximum investment returns (scoring aggressively) for their efforts. Yet, some are like "The Wall" Rahul Dravid who guard their nest eggs (have a solid defence) with a keen eye and firm hands, lest there be some unexpected loss of wealth. For this second group of investors, fixed deposits or savings accounts appear to be sure-fire ways to achieve their investment goals. However as an “invisible” but omnipresent enemy, inflation presents a great challenge to this notion.
Inflation is taxation without legislation.
As an enemy of the saver, inflation is invisible in the sense that it does not physically steal from you; rather, it manifests itself in the form of higher prices, which renders a rupee today less valuable than a rupee tomorrow. In recent years, we Indians have felt the significant impact of this invisible enemy in areas like food, shelter, transport and even in terms of healthcare needs.
To illustrate this point, consider a situation where you invest Rs.1 lakh of your money in a deposit which earns you 8 per cent a year. At the same time, the prices are also generally rising at the rate of 8 per cent a year. In such a situation, your compounding returns will just about keep pace with inflation.In effect, you have not become any richer. The rise in the amount of money you hold is just an illusion and is completely negated by a corresponding rise in prices.
But inflation may not be so kind as to stay at the level of the interest you are earning. What if it's more? And what if this goes on for a very long time. Suppose your returns are 8 per cent but inflation stays at 10 per cent and twenty years go by?
Your investment would grow to Rs.4.66 lakh but things that used to cost Rs.1 lakh would now cost Rs.6.72 lakh. Now, the purchasing power of your Rs.1 lakh is just Rs.69,000. Your investment has actually made you poorer! This is not a theoretical example- it actually happens to millions in India. In our country, over the past thirty to forty years, the inflation rate has been either the same or a little bit higher than many of the deposits that are available. Unfortunately, far too many people think of the two problems as unrelated.THE IMPORTANCE OF SEEKING A POSITIVE “REAL RETURN”
Over the past decade, India’s inflation has averaged well above 7%, although price increases have been more prevalent in recent years. What this entails is the inability of savings and deposits to generate a positive “real return”, that is, a return which can offset the effects of inflation on one’s savings, a pre-requisite for the preservation of purchasing power.
ALTERNATIVE OPTIONS FOR SAVERS?
One alternative is to shift up the risk scale, moving a portion of one’s savings into fixed income funds. While not guaranteed like bank deposits, these funds offer investors the chance to beat inflation and earn a positive real yield, default risks are also spread out owing to the diversified nature of the fund’s holdings. In addition to this Tax benefits are also available. A good way to get accustomed to fixed income instruments is to begin investing in Liquid funds which have shorter duration and lower risk.
You could also consider investing in Equity, although drummed risky it takes just a little thinking to figure out that inflation is riskier. And to match inflation, and get real returns on top of that, you have to latch on to something that goes up with inflation anyway. This is not difficult because the value of goods, services and assets in the economy is inherently inflation-linked. And so risky or not, equity and equity-linked investments are the only game in town to protect yourself from inflation.
Conclusion
The common problem in India is the inability to account for inflation. People think in nominal terms and the future impact of inflation is awfully hard to internalise. The real solution to this is that we should become a low-inflation economy but since that's clearly not on the agenda, savers should always adjust for inflation mentally.
Ninad Kamat
CERTIFIED FINANCIAL PLANNERCM
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