Sunday, 17 November 2019

Few Measures to Protect Your Finances During Inflation

One does not have to be a financial nerd to understand Inflation. It is the increase in the average prices of goods & services in a country. In simple words, a litre of full cream milk in Delhi used to cost Rs 24 in 2009 and, as of now in 2019, it has increased to Rs 53. The cost has more than doubled in the last 10 years. Its not necessary that other goods & services have increased at the same pace. In October 2019, the retail inflation stood at 4.62% vis-a-vis 3.38% in October 2018. Thus, one should regularly review their finances to make sure the real return (post tax) from your savings is either equivalent or more than Inflation otherwise you are losing the purchasing power of Rupee.

                                             (source: OER Commons)

Let say you deposit Rs 100 in your bank account which provides 4% interest yearly. Next year your deposit value is Rs 104, however if the inflation is 5%, you would require Rs 105 to maintain the same buying power. Below are few measures to adopt during inflation:

Avoid Fixed Deposits for Long Term Investments

FD's are the most common form of investments for bulk of Indians. One is assured the money is safe in the long run as it offers a fixed interest on maturity. However, investment in these products should be measured in real return earned and factoring the inflation rate. For instance, a 10 year FD offers around 6.75%-7% interest, which post tax (assuming one falls in highest tax slab) is left around with roughly 4.75% and slightly above current inflation level of 4.62%. For a long term investment to prove beneficial, one should aim for a positive real rate of return of more than 1%. Thus your long term investments should be limited to guaranteed products when inflation is rising.

Invest in Equities directly or via Mutual Funds

History has shown that investing in equities for long term has consistent beaten inflation and delivered better returns than fixed income products. Start investing in equities as early in an age group as possible as risk taking ability is higher during that time. If you are not sure how the stock market operates, always opt for Mutual Funds and let the professionals manage them. Also keep in mind, investing in equity means staying invested for a minimum 5 years as there may be a lot of volatility in the short term.

Allocate 10% of your investments in Gold

Gold is a useful commodity to hedge against inflation. Most of us know that the supply of this precious metal is limited. Hence, its price rise is directly proportional to the price rise in the economy. Investing in this commodity has proven useful and diversifies the portfolio, however, do not allocate more than 10% of your total investments in it.

Prepay Home Loans, if any

Interest on home loans mostly follow rising inflation, so your cost increases automatically. Also, RBI has made mandatory for banks to link home loan rates to external benchmarks like repos. One should always weigh the cost and benefits of prepaying the loan as if the situation is favourable, protect yourself from the burden of additional interest.

Protect the House Rent

For landlords, it is a tricky situation when the  same rent is finalized for two or three years and at the same time the inflation shoots up. Hence, by including an escalation clause in the rent agreement will make the landlord inflation proof.
For tenants, the purpose is to keep the rent at minimum with rising prices. One may end up paying higher than what was earlier agreed due to escalation clause. However, during low inflation time, tenants should negotiate with the landlord again and work on the overall rent amount.

To conclude, Inflation is a market phenomena that is impossible to completely avoid. It tends to reduce the consumer's purchasing power over time.  But if planned in the right way and investing in the right avenues matching the risk appetite, one may be able to minimize its impact on their savings.