How can I invest my money to stay ahead of soaring inflation? This was the biggest financial challenge for Indian investors in the last seven years. But that’s an old story.
Consumer price inflation, which climbed relentlessly from 2008 to 2013, has been declining since January this year, with the latest monthly reading of 4.98 per cent for October being the lowest in nine years. While one month’s number does not mean much, steadily dwindling inflation since January this year suggest that this could be a trend reversal. CPI inflation in the first ten months of 2014 has averaged 6.6 per cent, compared to 10.9 per cent in 2013.
As these price declines are driven by structural factors — rising shale oil and gas output in the US, China turning more self-reliant in commodities, high farm output and sluggish global growth — the trend looks set to continue for a while. If we are entering a low inflation period, this has big implications for your spending, saving and investing decisions.
Therefore don’t stop tracking your monthly expenses just because you feel inflation is easing up. If you’re a salary-earner, a direct consequence of lower inflation is slower growth in your monthly pay cheque.
If you are in a job that has a dearness allowance component, the slowdown in pay will be immediate. If you don’t, lower inflation may still mean smaller annual increments. In the last seven years, even as the economy went through the wringer, most Indian companies were forced to grant healthy wage hikes to their employees because of high official inflation. But now that inflation is easing off, salary hikes may be lower. Therefore, resist the temptation to splurge. Put off upgrading all the electronic gadgets at your home or paying more frequent visits to those wickedly tempting e-commerce sites. Instead, use the opportunity to expand your savings.
The prospect of lower salary hikes is something to factor in if you’re considering taking on an EMI (equated monthly instalment) too. You can no longer count on your salary growing at double-digit rates to make short work of your EMI.
Don’t borrow, save Economics tells you that high inflation favours borrowers over savers. This is why people who took a hefty loan to buy a home five or 10 years ago, find their EMIs quite easy to pay off today. Thanks to inflation, not only has the value of their home appreciated at a high rate, their income has probably expanded significantly too. In contrast to borrowers, savers have gotten a raw deal over the last five years. With returns on their safe investments far below inflation, whatever they have saved has looked like a pittance.
But with inflation moderating, this situation will now be turned on its head. As inflation slows, borrowers will find it an uphill task to service their EMIs, while savers will be quite well off with their investments likely to earn a healthy ‘real’ return. This argues for going easy on your borrowings and putting away a higher portion of your income towards savings.
Goldilocks period Today, we are still in a goldilocks period when inflation is moderating rapidly, but banks and small savings schemes haven’t cut their interest rates much because the RBI is still holding on to its high policy rates.
But this honeymoon will not last long, as interest rates are eventually bound to follow inflation trends. With banks beginning to trim deposit rates and market rates falling, the peak of this rate cycle seems to be already behind us.
Therefore, if you’re contemplating a big EMI to upgrade to a three BHK apartment, put it off for a while. Park that money in bank or top rated company deposits instead.
For Indian investors, high inflation usually creates pressure to take on more risk than they can stomach. This is because safe avenues such as bank deposits, post office schemes or debt mutual funds usually tend to generate lower returns than inflation.
To earn a higher return therefore, investors, irrespective of their risk profile, are forced to take on riskier equities, invest in gold or real estate. Each of these investments carry certain disadvantages.
Little liquidity
Gold lacks liquidity and doesn’t pay out any regular income. Real estate, given the large ticket size, can subject one to concentration as well as liquidity risk.
Equities aren’t really suitable for investors with a less than five-year horizon.
But moderating inflation will allow investors to make choices that are more suited to their risk profile and liquidity preferences. With less pressure to generate higher returns, conservative investors or those with a short horizon can stick to bank deposits, small savings or other debt investments.
There is no compelling reason to invest in gold as an inflation hedge. Nor does going overboard on real estate make sense. Both the appreciation in property prices and rental yields tend to closely track price rise, and may moderate with inflation.
What about equities? Well, your allocation to them should depend on how long you expect this low-inflation period to last.
If it’s going to last less than five years, you should continue allocating part of your portfolio to equities, so that you can be ahead of the game on long-term goals such as retirement or children’s education, in case inflation picks up again.