During high inflation times, calculate real returns to maximise wealth.
Any investment advice is always on where to put one’s money. And rarely is an investor told about investment avenues and instruments that he needs to avoid. There are various reasons that have to be well thought out before one invests - such as capital protection, liquidity, return, and so on. Given the current uncertain economic scenario, it is important to know which avenues should be avoided totally or partially at least.
INFLATION
The current inflation rate is a cause of major worry. As the value of the currency we hold declines, it leads to an erosion of our wealth. Since India is expected to show relatively healthy economic growth for the next 10-15 years, it is probable that overall inflation may remain high during this period. The immediate effect is decrease in purchasing power in the hands of the consumer and increasing interest rates. This scenario has a negative impact on the investment avenues discussed below.
| RISK-RETURN PROFILE | |
| Asset Class | Returns(%) |
| CNX Mid Cap | -27.0 |
| CNX Small Cap | -25.0 |
| S & P CNX Nifty | -16.0 |
| GOI Bonds | 8.0 |
| Post Office Savings Deposit | 8.0 |
| Bank Fixed Deposit | 8.5 |
| Real Estate(Metro areas) | 50-60 |
| GS Gold BEES | 63.0 |
| REMEMBER... |
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Fixed income instruments: Many banks have a special interest rate for senior citizens. At 9.5 to 10 per cent, this is higher than that offered to other deposit holders. So, naturally, investors are lily to get attracted to these. Yet, if the inflation rate is 10 per cent and the bank offers a pretax interest rate of 9.5 per cent you are losing your money. Simply because, post tax it works out to 6.7 per cent. This is also the case with Government of India (GOI) Bonds, post office deposits and other small savings schemes.
Insurance savings products: Insurance savings product may also be avoided for three reasons. First, they have high costs associated. Second, due to longer tenure, the returns you get may not cover the drop in purchasing power. Third, insurance products should be purchased to cover risk, not generate returns.
Small and mid-cap companies: In a high growth economy, rising interest rates put a lot of pressure on smaller companies for debt servicing. The high interest cost results in lower profitability and affects their valuation. This results in a depressed market for these companies. In India, the CNX Small-cap and Mid-cap indices are one of the worst performing ones for the past two years. The two are down by 25 and 27 per cent, respectively, in the past two years.
The table shows the absolute returns generated by the asset classes during the past two years:
INVESTMENT STRATEGY
So, what is the course of action during high growth and high inflation scenarios? Here are some strategies to mitigate the risk during such times.
Diversified portfolio: In all circumstances, whether bullish or bearish market, diversify over asset classes. Diversification mitigates risk and enables us to maximise returns. As shown in the table, different investment avenues have generated returns from a negative 27 per cent to a positive 63 per cent. A diversified approach can help balance returns and provide stable income at all times. Investment in commodities such as gold may be considered, for it is a natural hedge against inflation. Real estate is a good investment avenue. It does require huge investment and can be considered, provided you do not need immediate liquidity and can hold on to these for a longer duration.
Systematic approach: This helps in better planning. There are no sure-shot solutions for making money in your investment. Investors should understand that they operate in a dynamic environment. Any investment decision should be through due diligence.
In sum, try to calculate the ‘real return’ to be able to maximise wealth.
The author is a freelance writer
