Effect of inflation on investment:
When you begin investing in stock market, you should know the pros and cons of investing in various assets especially the effect of inflation on stock market. Let us understand the impact of inflation on stock market and also how one can invest in an asset that can probably give high rate of returns thereby resulting in surplus income which will help in attaining one’s financial goals and also beat inflation. You should not shy away from investing due to inflation impact on stock market but rather know how to overcome inflation effect on stocks and other assets.
What is inflation?
Inflation indicates the increase in prices of goods and services in an economy and as an investor, it is very essential to know what inflation means and how does inflation affect savings and investing. The value of money decreases with time and this means that whatever you could buy today for a particular price, you cannot buy tomorrow.
One should know about nominal rate of return and real rate of return as an investor. Nominal rate is the rate of return which you get that is not adjusted for inflation whereas real rate of return is used to find out the effective return after it is adjusted for inflation.
Inflation tends to decrease the value of money and hence you should know how to overcome this by choosing better investment options that would provide you with higher returns capable of beating inflation.
Formula to calculate real rate of return:
Real rate of return = (1+Return)/ (1+Inflation Rate)-1
If the return from a bank FD is 7% per year and if inflation touches 5%, then the real rate of return you will get is 1.9% only due to inflation.
Effect of inflation on investment:
Savings especially in bank fixed deposits suffer due to inflation. Many of us feel that bank FDs are the safest and so park our money there but inflation erodes the value of our savings. Let us understand this with an example. For instance, you have Rs. 500 in your account. If you receive an interest of 5%, your savings would become Rs. 525. In the same period, if inflation rate is 10%, price of an item which was Rs. 500 earlier would become Rs. 550 now. In spite of the growth in your investments, you have to spend more due to the increase in inflation. It can also be said as negative rate of return. The real return you get from investment is reduced due to inflation.
Fixed income instruments:
As inflation increases, the value of your investment in bonds which pay you fixed interest rate decreases. To overcome this, you can invest in bonds issued by government that are adjusted to inflation risks.
While calculating the amount required for your retirement plan, you should not forget to adjust the value of current expenses in accordance to inflation that will help you in calculating the cost of the expense at the time of your retirement. If there is inflation, then the amount you allocate for retirement has to be increased to catch up with inflation and in case if the returns are high, it will automatically reduce the savings that are needed to make up the retirement corpus.
Ways to tackle inflation:
Start investing in shares/mutual funds:
Investing in equities or shares is one of the best methods to beat inflation. One can also invest in SIP (Systematic Investment Plan) for a longer time period that will help in fighting market volatility and inflation as well. Companies those are fundamentally strong can tackle inflation and can start generating profits and so one has to invest in these kinds of companies. There are many mutual funds that provide high returns which are adequate enough to tackle inflation.
Invest in commodity:
You can invest in metals like gold and silver as these have always been used as hedge against inflation. When the value of currency decreases, investors turn to the safe haven (gold). You may also invest in gold ETFs as well.
Nobody can avoid inflation but can always plan and invest in the appropriate investment avenues and also diversify investment to beat inflation. You can also read about the impact of inflation on Indian stock market to know how and where to invest to tackle inflation.