Inflation seems to be returning not just to the domestic economy, but also globally. With rising commodity and oil prices, inflation may not be far behind. However, whether it is only transitory or will become a permanent feature, remains to be seen. Central banks worldwide, including the RBI, are expected to take monetary measures to keep inflation in check. Similarly, as an investor, you also need to take certain measures so as to keep your portfolio inflation-proof or to minimize the impact of inflation on your investments.
Have a look at your current asset allocation pattern and see if a tweak is required in the mix to not only protect the portfolio but also gain during inflationary times. Here’s how you can do it.
Equities beat inflation
Equities have outperformed other asset classes and generated high inflation-adjusted returns over the long term. Within equities, the ideal route to take for retail investors is mutual funds, preferably through the SIP (systematic investment plan) route by linking them to their long-term goal. Therefore, build your equity mutual fund portfolio with a few consistently performing schemes linked to your long-term goals. Ideally, diversify across market capitalization, sectors and avoid going overweight on any specific sector.
Stock market indices are at a high and valuations of several stocks appear to be expensive. However, as a retail investor taking exposure through MFs, one should not be perturbed because of these factors, and trust the fund manager to take a view and act accordingly.
For a retail investor considering equities for the long term, there is no such thing as 'right time'. Rather than trying to time the market, it's the time in the market that is important for building wealth. Stock markets do not travel in a linear route and there can be several dips and spikes over a long period. One may use the dips as an opportunity to add more to the portfolio, rather than making ad-hoc investments. Equities typically drift upwards over the long term and, therefore, you must link your goals to your investments to reap the benefits.
Hedging via Gold
Gold has always been considered as a hedge against inflation. At least 10 per cent exposure to gold, preferably through gold bonds, may be considered by investors for their long-term goals. In times of high and runaway inflation, gold prices tend rise sharply. Do not go overweight on the yellow metal. Some exposure through sovereign gold bonds may still be considered.
Impact on debt funds
Rising inflation means falling purchasing power of the rupee. Effectively, inflation eats into the returns generated by any financial instrument such as equities and bonds. A bit of inflation, with a corresponding rise in interest rate, is inevitable when the economy shows signs of growth. How far the RBI is able to tame it, remains to be seen over the next few months. Therefore, there may not be an immediate impact on stock prices unless inflation moves into uncontrolled territory.
Bond prices are inversely proportional to the movement of interest rates. When inflation rises, the rate of interest also moves up, leading to a fall in bond prices. This is because new investors dump existing bonds carrying a low coupon rates in anticipation of new securities that come with a higher rate of interest. So, if there is an expectation of rising rates (because of inflation), bond prices fall and so do the NAVs of debt funds.
When inflation rises, the bond yields increase and prices fall, which happens in anticipation of rising interest rates. This is a crucial period for debt fund investors, as rates may start to move up even though the RBI has been taking steps to keep it low. So, in these circumstances, investing in debt funds with a lower maturity period helps rather than buying long-dated debt funds. Choose to park funds in short-term or medium-term debt funds rather than debt funds with longer maturities.