The effect of inflation is multi-dimensional which not only limited to reducing the purchasing power of households but also has a major effect on the investment and savings. In fact, the effect of inflation on investments is two-sided, hurts when it’s both at the higher and lower side.
Higher inflation can severely impact market returns, savings returns and reducing the purchasing power. Whereas, lower inflation also doesn’t add value to your investments, as it is associated with weakness in the economy.
Let us have a look at the effect of inflation on different investment security types:
Equities are least affected by inflationary conditions, and the returns are purely dependent on the performance of companies. Stronger the fundamentals like growth in earnings and profit, higher will be the price of the security.
Bond investors are highly affected by inflation and at times, the real return from the investments falls to zero. That’s why inflation is termed as a demon for retirees, who are living off a fixed income and always need to be more careful.
For example, you have invested Rs 10 lakh in a fixed income product a year ago at a 9% yield. Now, you are supposed to collect Rs 90,000 as interest income, but is it worth the same as it was a year ago. Definitely no, assuming the positive inflation of 3%, then your net return stands at 6%, thus reducing your overall purchasing power.
So, is there any protection against inflation for investors in bond or fixed income securities? Yes, the Inflation-Indexed Bond Fund helps to ease the pain of inflation on such investments.
The capital growth or the coupon payments on inflation-indexed funds are linked to inflation rates and provide safe returns. The rate of return is a bit on a lower side compared to other bond funds, but it ensures ample protection from the inflationary conditions.
Precious metals like gold, silver are beneficiaries in an inflationary condition as they offer a good hedge against inflation. When inflation continues to remain high over the long term, the value of money falls which pushes the gold and silver prices higher.
On the other hand, commodities which are basic and is of everyday use, like oil, wheat, pulses, it gives a little advantage to investors as a hedge against inflation.
Inflation is like a silent killer of your money. And, inflation has a more negative impact on the short term investments rather long term investments because of the effect of compounding. So, while planning your finances, always be aware of the effect of inflation and plan ahead to mitigate its risk on overall investment returns.