Inflation, Inflation, and Inflation. Most of the discussions are around inflation. Inflation affects everyone, from conference rooms to food stores. Prices are increasing more than ~8% in the United States, the highest in the last 40 years. Similarly, in many European nations like Germany and the UK, inflation is hovering around ~ 10% last seen during the 1990s. In India, inflation is around 7-7.5% last seen during the 2012-2014 period. Inflation is robbing you of your hard-earned money!
But first, let’s see what is Inflation.
Inflation is defined as an increase in the prices of goods and services, followed by a decrease in the buying power of each rupee. As inflation grows, each rupee is likely to purchase fewer products. Inflation is one of the primary reasons that cause the value of your money to depreciate over time. It implies that the money you have at the start of the year will buy you fewer products and services by the end of the year.
Let's see an example :
Let's say your monthly expenses today are around Rs 30,000, with inflation of 5% next 5 years would be ~30% more, similarly, ~65% more money would be required for the same expenditure at 5% inflation in 10 years, and in 20 years about Rs 80,000 (2.7x) assuming 5% inflation. So goods that can be bought at 30,000 would need 80,000 in 20 years and more if inflation shoots up.
Similarly, Rs 1,00,000 kept as cash for 10 years at a 5% inflation rate would be worth only ~ Rs 61,000 losing 40% of its value. And in 25 years will lose more than 70% of its value to just ~ 29,500.
But how does it impact a normal person?
Well, Inflation is not a new occurrence. It has been thoroughly researched throughout the years, with its effects extensively analyzed. While inflation can help grow the economy in nominal terms, too much of it can destroy it.
Let's first see how Inflation can cause discomfort in day-to-day lives:
Income distribution inequality rises
Profits for company owners and entrepreneurs rise during periods of inflation. People in fixed-income categories, on the other hand, see a decrease in their real income. As a result, income disparity becomes significant throughout this era.
Reduces purchasing power
The immediate effect of inflation is a decline in purchasing power. The amount of products and services that a currency unit may buy is referred to as its purchasing power. As inflation grows, you'll have to spend more money to get the same amount of goods or services, reducing your purchasing power as was explained in the above example.
Currency drops
Money loses its asset value when prices rise and the domestic currency exchange rates depreciate. The value of a currency falls because it costs more to import the same quantity of goods and services.
Inflates Interest rates
Inflationary pressures indicate an excess of the money supply. Higher interest rates are one approach to limit the amount of money flowing into the economy. Raising interest rates has been a tried-and-tested monetary policy tool for dealing with inflation. When inflation is strong, central banks raise interest rates to discourage borrowing and keep prices from rising further. When interest rates rise, you tend to save more by reducing your spending. As a result, the money supply shrinks, making it more scarce and precious.
Increased Living Costs
It goes without saying that when the cost of things rises, customers will have to pay more for both essentials and indulgences. This may not be an issue if income increases in accordance with inflation, but those who do not will confront greater actual prices. In other words, they will be required to spend a greater proportion of their income on the same quantity of goods.
Now that we have seen what inflation is and how it affects us let's see
HOW TO BEAT INFLATION?
First, can we beat inflation?
Short answer YES! You definitely can by creating wealth that outperforms the inflation rate. Long answer? Let's see how :
Limit your wants/ Do not take much debt
Charlie Munger, Buffett's business partner, and Berkshire Hathaway vice chairman has his own ideas about how to deal with periods of excessive inflation: "Not having a bunch of dumb needs in your life is one of the great defenses to being worried about inflation," Munger told Berkshire shareholders in 2004. "In other words, if you haven't generated a lot of false need to drown in commercial things, you have a significant shield against life's uncertainties." Limit your wants, do not take unnecessary debt, and reduce debt as early as possible.
Improve productivity
Buffett reiterated his time-tested advice in his speech at the Berkshire Hathaway annual shareholders meeting in 2022, saying that one of the best ways to combat inflation is by honing your abilities and striving to be the best in your industry. Buffett emphasized that, in contrast to money, abilities are inflation-proof. Whatever the value of the dollar, if you have a skill that is in demand, it will always be so. "Whatever skills you possess, they cannot be taken from you. They actually can't be inflated far enough away from you, he explained. "Anything you develop yourself is by far the best investment because it's completely tax-free." Improving your productivity and skills is the best action during inflation.
Invest in Equity Assets
One of the greatest methods for consumers to combat inflation is to invest in assets with returns that outperform the rate of inflation. Experts often advocate investing in equities or equity-oriented funds rather than storing cash or in fixed-income securities. This strategy helps you to diversify and increase your portfolio while reducing your chance of losing money due to inflation.
Mutual Funds
Equity mutual funds are an option for investors who do not want to invest in individual stocks. There are several sub-categories of equity funds that can meet the needs of various types of investors. There are market capitalization-based equity funds, sectoral funds, equity funds based on investing methods, tax-saving funds, and more.
Do not keep all your eggs in one basket
We have heard this multiple times but it's finally time to act on it. DIVERSIFY your portfolio. Few investments promise high returns but they also come with high risks. Diversify keeping your portfolio after due consideration to age, risk profile, goals, needs, liabilities, income, and inflation while planning.
Review and Rebalance your portfolio
Periodic review and rebalancing of your portfolio help change the asset allocation in your portfolio in response to long-term market circumstances. Volatile fluctuations in inflation rates, changes in financial goals, and a variety of other circumstances may require portfolio rebalancing and/or re-allocation. A portfolio built in 2010 with the economy and inflation rates in mind may not work for you in 2022.
BOTTOM LINE :
Wealth is created by generating returns that are higher than inflation after paying taxes on generated returns. The biggest enemy of wealth creation is spending on things we don't need, low productivity, inflation, taxes, and remaining underinvested. If you do not invest, you are simply allowing inflation to rob you of your hard-earned money. Your money's worth is diminishing by the minute, and you're doing nothing to stop it. This is why it is critical to invest in equities or Mutual Funds that may outperform inflation by a significant margin and too on a tax-adjusted basis. To check your financial well-being one must review his/her financial plan periodically with their financial advisor. Just like an apple a day keeps doctors away, a periodically reviewed plan keeps bugs of inflation away!
Happy Investing! Stay Healthy! Stay Invested!
Logon to https://tikonacapital.smallcase.com/ to know more
Sumit Poddar
Chief Investment Officer & Smallcase Portfolio Manager
Tikona Capital
Comments