What will be your monthly expenses after one year due to inflation?

For starters, inflation is the rate of increase in the prices of goods and services over a period of time. The supply of money kept in circulation by global central banks during the pandemic to shield economies from the COVID-19 crisis has increased costs both globally and domestically.

While a moderate inflation rate is good for an economy, high levels are considered harmful.

At the individual level, high inflation leaves less money for savings and discretionary spending followed by household expenses. Moreover, it also negatively affects the return on your investment.

And hence the phrase ‘inflation eats into your returns’. This means that the returns from your investments, despite earning good returns, are reduced if the costs also increase at a faster rate due to inflation.

For example, let’s say you plan to go on vacation next year and start saving every month to build a corpus. 1 Lac. In the next year, if costs add up even faster than expected, you may have to spend more money to enjoy the vacation you want, or you may have to compromise on some experiences.

Thus, understanding inflation-adjusted returns, otherwise called the real rate of return (RRR), is very important for effective financial planning. The actual rate of return before adjusting for inflation is called the nominal rate of return (NMR). The actual rate can be calculated by simply subtracting the inflation rate from the NMR.

We looked at the real rate of return, which was distributed over the short and long term in India across asset classes such as equity (including international), debt, gold and real estate.

In the past one year, all asset classes except gold gave negative RRR, as the rate of inflation exceeded investment returns (see table). Gold, on account of rupee depreciation, may generate positive RRR in rupee terms; In dollar terms, gold gave negative RRR as well as NRR, raising questions about its ability to hedge against inflation.

In the long run, equities (including international stocks) have been the only asset class with a clearly meaningful RRR. The actual return from loans (fixed deposits, or FDs) is only in the range of 1-3% per annum, indicating that it only protects capital. It may beat inflation marginally but not significantly. Sleep, despite bouts of intermittent outperformance, has lagged behind with a minimum RRR of less than 1% over the 10-year period. Residential real estate property has been the worst performer with negative RRR during the period of 3-5 years.

Equity: Winner

equity It has a proven asset class that can beat inflation in the long run because of the ability of companies to pass on costs to their clients. In the time frame of 5 years and 10 years, the equity asset class represented by Nifty 50 has given real returns of 8-10%. “Pricing power lies with the providers of the products we use. When the cost of these products goes up, it is natural that the source of inflation protection is likely to be equity,” said founder and founder of Plan Ahead Wealth Advisors. CEO Vishal Dhawan said.

Within equities, investors should focus on companies with higher earning potential, said Anish Teli, founder, QED Capital Advisors. “As long as earnings are rising, regardless of volatility, it will generate returns in the long run”, he said.

Also, having an international equity exposure in a portfolio has gained traction over the years and an asset allocation without it is considered incomplete. As per historical return data, international equities represented by the S&P 500 Index have outperformed both in terms of NRR and RRR. Kalpen Parekh, MD and CEO, DSP Mutual Fund said that he also classifies international equities under the equity bucket. “Over the very long term, global equity returns will match that of Indian equities and vice versa. Due to some temporary cyclical factors, there are years when global equities outperform Indian equities and there are times when it looks cheaper. I compare them both just to decide which one is relatively cheap to invest. For example, now is a good time to invest in global equities, which have declined 20-25%, while Indian stocks remain flat.”

minus: a stabilizer

We cannot expect significant inflation-beating returns from the fixed-income segment. As per prehistoric data, the actual returns from FDs have been only 1-3%.

“Whether you are making a substantial real return on debt or not, your portfolio should have debt investments, which will allow you to take risk while investing in equities, which will generate a really high RRR.” Ravi, Co-Founder, Samasti Advisors “Provides stability to the loan portfolio during market turmoil,” Saraogi said.

According to Parekh, 70:30 Equity: Debt portfolio, with periodic rebalancing to maintain the weight, will generate returns similar to equities, but with levels of volatility close to that of debt.

One way to maximize real returns from debt, said Dhawan, is by investing in credit risk instruments (including debt instruments other than G-secs and issued by companies). It is a slightly higher risk investment with higher return potential as compared to FD

Gold: A Diversifier

For a long time, gold has been regarded as a hedge against inflation. But for many experts, gold is more diversified than a hedging asset.

According to Saraogi of Samasti, this precious metal, which is considered a safe haven in times of economic crisis, has a longer market cycle than equities. This is reflected in the 10-year return from the asset which has been just 6.4%, with the actual return being less than 1%.

“It is an emergency asset class in a portfolio, and behaves very well when everything else is not due to negative correlation with other assets,” Dhawan said. A 5-10% exposure to gold can provide some strength to the portfolio. Extreme volatility, experts say.

Real Estate: Low RRR

In India, real estate has been the preferred asset class for investment over the years. However, it hasn’t been a great performer. Over a 10-year period, the real return from assets was just 2.3% CAGR, according to the Reserve Bank of India’s All India House Price Index.

The index has been calculated on the basis of data received from housing registration authorities in 10 major cities (Ahmedabad, Bengaluru, Chennai, Delhi, Jaipur, Kanpur, Kochi, Kolkata, Lucknow and Mumbai).

“The rental yield in India is around 3% with not much capital appreciation. If one is buying property to earn tremendous returns, I think it is not right. Having said that, it is perfectly fine to buy a property for non-financial reasons. Life is not an Excel spreadsheet,” Saraogi said.

He further added that the logic is different for commercial real estate. “For those who want to invest in real estate, investing in REITs (Real Estate Investment Trust) is a better option.”

conclusion

Earning a negative real rate of return on investment can destroy one’s purchasing power in the long run. Paying attention to expected RRR and using projections of future inflation can help you decide how much to save and how much to save, taking into account one’s risk appetite and the inherent volatility of each asset class. How to make appropriate asset allocation.