Make Your Portfolio Inflation-proof

Inflation is crucial to investing as it reduces the value of your money over time. Therefore, keeping up with the rate of inflation, to protect the value of investments, should be the top priority for every long-term investor. Remember, the ability to earn a positive real rate of return, i.e., gross returns minus taxes minus inflation, would depend upon the composition of the portfolio. [EasyDNNnews:PaidContentStart]

While the nominal return represents the growth rate of one’s money, the real rate of return represents the change in the purchasing power of the money. Simply put, it’s actually the real rate of return that indicates whether the money is growing in value or not. 

Since most investors keep their focus on the safety of capital and invest a major share of their investible surplus in traditional options offering guaranteed returns like FDs, bonds, and small savings schemes, this important aspect of earning a positive real rate of return gets overlooked. Investors must know that inflation is a far bigger risk than the safety of capital while building a portfolio for some of the most important long-term goals like children’s education and retirement planning. 

Moreover, considering that most of the traditional investment options offer lower returns and are taxed at one’s nominal tax rate, the real rate of return usually turns out to be either negative or minimal. While it is true that a higher inflation regime allows investors to earn higher interest on their fresh investments in FDs and bonds, the tax inefficiency of return negates that benefit to a large extent. Therefore, investing in a variety of tax-efficient Hybrid Funds can make a difference to the real rate of return. Of course, one needs to have absolute clarity in terms of time horizon and the risk profile while doing so. 

The first step towards staying ahead of inflation should be to have an investment strategy in place. It can be quite challenging to develop a strategy that not only withstands the ups and downs during different market conditions but also helps in tackling inflation. However, the correct asset allocation, based on one’s time horizon and risk profile, and maintaining it through one’s defined time horizon can produce the desired results. Another important step that needs to be taken is to curb the expenditures by following budgeting. By doing so, more money will be available for investments every month, resulting in a larger corpus over time. 

While investing for the long term, equity should be the mainstay of the portfolio as it has the potential to beat inflation. As an asset class, it scores over others, as returns are taxefficient. For example, any capital gain arising out of an investment redeemed after 12 months is treated as a long-term capital gain. While long-term capital gains eon an investment in an equity and equity-oriented fund are taxed at 12.5 per cent, short-term capital gains are taxed at 20 per cent. However, there is no tax on long-term capital gains up to ₹1.25 lakh in a financial year. 

To be a successful equity investor, one must be well-versed with the challenges too. Considering the volatile nature of the stock market, it’s important to honour time commitment and follow a disciplined approach. Regular investments can turn the stock market volatility to one’s advantage through averaging and significantly improve the probability of staying ahead of inflation. 

Besides, if the portfolio has a substantial exposure to equity, the impact of higher inflation during certain periods could be in the form of falling portfolio valuations. That’s because rising interest rates spell trouble for corporate earnings as well as the stock market. However, in the long run, corporate earnings are generally able to outpace inflation. As is evident, the extent of success in staying ahead of inflation decides how secure one’s financial future would be. Thankfully, there are strategies that, if followed diligently, can help investors’ portfolios remain on track to earn a positive real rate of return. 

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