In the past few months, though the wholesale price index has been dropping, the consumer price index, which tracks inflation for end consumers, has been really high - and trending upward. The WPI is at 4.7 per cent, the CPI at 9.3 per cent; that's 4.6 per cent higher.
You may have noticed that prices of all essential household items have shot up considerably in the last few years. Prices of regular day-to-day items have risen significantly, in some cases up 30 per cent over the last two years. Prices of milk and sugar have jumped 50 per cent in the last three years. That is what causes wallets to shrink.
Inflation not only makes goods and services more expensive, it also makes saving more difficult since the greater the inflation the less the actual savings. For example, if the inflation rate is 5 per cent and the interest rate is 10 per cent, one's actual returns will only be 5 per cent (This assumes no taxes. Where taxes are payable, actual returns would be even lower.) Hence, any investment avenues which offer returns lower than inflation actually result in loss of value of the capital (in nominal terms) over a period of time.
Here are a few investment avenues that could offer inflation-beating returns.
1. Embrace equities for the long term
This is one of the best methods of beating inflation, as equities have always given superior returns over the long run. Another benefit of investing in equities is that since one is investing in companies which themselves are growing at a reasonable rate, the rate of returns should typically be more than inflation in most years. This is a high-risk, high-return strategy but almost unavoidable if beating inflation over the long term is a definite objective. One can invest in equity mutual funds or even directly in stocks if one has sufficient knowledge of the stock markets.
2. Lock into good corporate debt
Several large companies offer fixed deposits or bond schemes which can turn out to be good investment options. These companies typically offer returns in the range of 14-18 per cent p.a, which should suffice to beat inflation. However, note that this is a high-risk option because one not only would one take on economic and industry risk, one would also face the risk of the company going bankrupt, etc. It is advisable to invest only in blue-chip companies or offers that are rated high by one of the credit-rating agencies. This investment is suggested only for those who have a high-risk appetite.
3. Diversify across the globe
Investors can look to diversify their portfolios with global investments, either directly or through global equity mutual funds. This would enable an investor to diversify investments geographically as well as benefit from growth in other parts of the world. This has the dual advantage of beating domestic inflation and diversifying investments.
4. Consider property investments
This is another high-risk, high-return investment option that can yield inflation-beating returns. The advantage with property investments is that returns are typically very high, often many times the original investment. The drawbacks are many, however. Property is typically illiquid; a glut in the market may result in years before an investor realised any returns. Also, there is much paperwork and legal issues involved in purchasing and selling property. Property also requires a large corpus to begin with.
5. Look at tax-efficient schemes
Some government savings schemes such as the Public Provident Fund, Post Office Savings Scheme, and National Savings Scheme are good options to invest in because security of capital is guaranteed. Returns are typically around 9-10 per cent, which should beat inflation in most years. In PPF particularly, because the returns are not taxed, and investors get better post-tax returns.
6. Don't ignore inflation-indexed bonds
The government recently announced inflation-indexed bonds that would help combat rising inflation. These bonds essentially provide an investor with capital protection from erosion of value due to inflation. They typically carry an interest rate that would be added to the inflation rate to give a rate of return for the year. For example, if a bond offers a 3 per cent real return and inflation hovers at 8 per cent, an investor would earn 11 per cent that year; if inflation is only 5 per cent an investor would earn 8 per cent. These bonds are a great savings instrument when inflation levels are very high. Other investment options, however, are better in periods of low inflation. Remember, this will only beat WPI and not CPI.
Keep in mind the tax rules applicable on the various kinds of investments in one's portfolio, since taxation would determine the final returns on that portfolio.