What is inflation?
Inflation is a key factor that affects your Investments and disrupts your financial plan. While inflation has been relatively contained for the past several decades, it has recently spiked to levels not seen since the early 1980s.
Simply put, Inflation means an increase in the prices of goods and services produced and consumed in the economy. In another way, it reduced the purchasing power of your money.
What does it mean for you?
- Erodes/reduces your purchasing power. Things you could buy for INR 1000 have reduced over time
- It can be bad for some investors who are sitting on cash as it reduces the value of cash but could also give good opportunities to invest as equity markets become volatile & corrections are expected.
- Can be good for real estate, commodity, and gold investors as it tends to increase the value of things.
What are the causes for the rise in inflation?
There are many reasons for the rise in Inflation, majorly because of the increase in the supply of money during COVID and lesser goods/services in front of it. Too much money chasing fewer goods.
- We are recovering from 2 years of lockdown, where we want products and services of all kinds. The demands have increased. (demand-pull inflation)
- For those goods and services, the supply is limited because of supply chain problems in China, everyone has not returned to work (reduced labour), and existing labourers/employees demand higher wages for the increase in the price of goods. (cost-push inflation)
- This excess demand has led to an increase in the price of goods and services which in turn is also affecting inflation and our demand for higher wages.
What is the government (Central Bank - RBI) doing to control Inflation?
The Reserve Bank of India (RBI) raised its key repo rate by 50 bps to 4.9% during its June meeting, after May's surprise 40 bps off-cycle hike, surprising markets had forecast a 40 bps rate hike, aiming to ensure inflation remains within target going forward while supporting growth. The board decided to revise upwards its inflation forecast to 6.7 per cent for FY 2022-2023 from 5.7 per cent. This should have an impact on reducing the demand-pull inflation. However, it may take a while to get the supply side (cost-push) inflation in check.
Watch our Youtube video to understand what is the impact of inflation on the interest rates.
The above graph shows that when inflation rises, the interest rate rises and with the fall in inflation, the interest rate also goes down.
How Inflation affects your Investments?
I. Impact on Equity
- High inflation reduces the demand for goods and services - impacts the revenue and profits of companies.
- With High Inflation comes high-interest rates, making loans/funding expensive - companies could push their expansion plans. This would have a bigger impact on companies with more debt.
- With increased interest rates globally, FII would pull out money from Indian stocks to invest in bonds (safer options)
- Increased inflation depreciates Indian currency, making Indian stocks less attractive as compared to foreign stocks. This may result in a vicious cycle as FII outflows lead to further currency depreciation.
The above graph shows that a rise in interest rate was followed by a correction in the market.
Please note: There could be other variables as well working around the time to affect the market. And the market has corrected over a period of time post that. Do note that historical numbers are not a representation of what will happen in the future.
II. Impact on Debt/Fixed Income
- Interest and returns have an inverse impact on long-term debt products. Where the interest rate reduces, the price of such funds increases, and in an increasing interest rate scenario, long-term debt funds reduce. This is because long-term funds are invested with debt securities with earlier interest rates and longer maturity.
- Short-duration debt funds/FDs become more attractive because they offer higher returns in line with the increased interest rates.
III. Impact on Gold
With the increase in inflation and fall in equity markets, people tend to use gold as safe haven which could push its prices even higher. However, gold is already trading at a high premium so it is difficult to analyze how it would move from here. Do remember that gold is also volatile
IV. Impact on Real Estate
The increase in the cost of raw materials combined with higher interest rates would make it a tricky situation for real estate. However, the money from Equity could find its way back to real estate. Despite all this, real estate is always driven by location, location, and location. You must study the local area market scenarios and prospects before locking your money in real estate. Check our course Money & Makaan to learn more about it.
How should you Invest during inflation? - Wealth Cafe Advice
Stick to your asset allocation, it will guide you on what needs to be done with your investments - when you need to sell and when you need to buy. Do not get distracted from your goals and the money needed for those, for short-term goals - invest in debt, for the long term (more than 3 years) - explore equity.
Do not stop your long-term Investments SIP - Where your short-term and mid-term goals funding is provided for through your debt investments, then you should continue your equity SIPs. It is in these corrections that you get the opportunity to create wealth. Equity is the Investment that can beat inflation, and increase the money in your hand.