Don't let inflation erode returns

Avoid investing in interest rate-sensitive sectors which are likely to underperform.

The news of the headline inflation figure for April dipping to 8.7 per cent from 9 per cent year-on-year in March has not brought any cheer to consumers. High inflation in the past years has already led to higher household expenses, a dent in savings and lower returns on investments.

“Inflation started soaring due to the rise in fuel prices. Last year, it was due to food prices. Inflation is rather sticky right now and is refusing to come down easily. It will take some more time to decline,” says Dhawal Dalal, Senior Vice President & Head – Fixed Income at DSP BlackRock Investment Managers.

According to the Central Statistics Office, April saw almost all the items in the wholesale price index (WPI) basket rising. On a month-on-month basis, food articles went up by 2.5 per cent and non-food items by two per cent.

Experts say while the consumer has no choice but to bear the rise in core consumption items, he has to learn to live with the times. “Consumers can strategise on the non-core consumption basket front by downtrading, that is, purchasing non-premium versions of products that effectively deliver the same utility,” says Ritika Mankar, economist, Ambit Capital.

In terms of investments, high inflation compresses returns across asset classes and the effect is more prominent in the case of low and fixed interest earning instruments like fixed deposits (FDs).

According to Rajesh Saluja, CEO and Managing Partner of ASK Wealth Advisors, “Even if one invests in FDs for longer terms of three to five years, the returns won’t beat inflation.”

For instance, the interest rate on a two-year deposit is 8.25 per cent and on a one-year FD is 7.75 per cent. With inflation at 9 per cent, you would be trailing inflation by one per cent since it is higher than your interest rate.

In the last one year, returns from diversified equity funds too dipped 0.97 per cent. 10-year G-Sec bonds fell 0.49 per cent while the Nifty gave marginal returns of 0.37 per cent.

Yet, investment advisors say one should be looking at growth assets like equities and real estate to beat inflation. Adds Saluja, “Even though real estate is a high-risk asset class, if you select a good property, the returns can be equally high.”

Real estate as an asset class has given returns 15-16 per cent on a compounded basis. If one were to invest in “good blue chip” scrips for longer periods of 7-10 years, it could be very rewarding.

The issue with real estate investment is that in many parts of the country, especially in metros, the prices are quite high and a correction is expected. But, historically, real estate has given better returns over longer terms and so has equity as an investment class.

One could also look at investing in gold when inflation is very high and is showing no sign of tapering off. Traditionally, gold has been a hedge against inflation. It is seen as a store of value and hence protects capital. However, returns have been around 25 per cent per annum in the past few years.

Even borrowers are feeling the pinch of rising inflation. In its bid to tackle inflation, RBI raised interest rates nine times in the last one year. Says Dalal, “With rising interest rates, the loan payers’ outgo will increase. They will spend more on credit, that is on equated monthly instalments.”

Inflation is expected to ease to 6 per cent by March next year. A good monsoon, along with the RBI going easy on rate hikes and easing of the global commodities prices could see inflation dip a little bit.

But, until then, avoid investing in interest rate-sensitive sectors likely to underperform.

Dalal’s advice to investors: Put your money in short-duration investment avenues. Once the asset matures, you can re-invest the money in higher yielding products.