There has been a steady increase in the cost of goods and services in the last year due to a rise in inflation. Earlier, inflation was expected to be transitory or short-term in nature and it was believed that the prices would decline once the disruption to the global supply chain due to the COVID19 pandemic subsides.
The fear has been heightened due to a global spike in commodity prices following the ongoing war between Russia and Ukraine.
High inflation for an extended period can have a big impact on our finances. While the rise in the cost of living will put stress on our cash flows, its impact on different asset classes and sectors can also hit our savings and investment portfolio. Here are some steps that you can take to mitigate the negative effects of inflation on your finances:
1. Reduce cash and diversify your investments. It is very comforting to have a big wad of cash in your wallet or your banks’ savings or current accounts but cash is trash according to the renowned American billionaire investor and hedge fund manager Ray Dalio. This is especially true in times of high inflation that erode the value of cash holdings.
So it becomes important to reduce the cash component in your overall portfolio and hold assets instead that can either grow in value due to inflation or can provide yields that are closer to inflation. Such a diversified portfolio can include stocks, commodities, real estate investments trusts, high yielding bonds or fixed deposits or inflation-indexed bonds.
2. Review your existing portfolio. As would be obvious to most investors, high inflation can cause a lot of volatility in financial markets with sharp rise and fall in the prices of stocks, bonds and exchange rate. A wrong or a premature move in such a market can ruin years of gains. Besides, not all sectors and industries are affected uniformly by high inflation.
Given this, review your portfolio and try to imagine how it will behave in an environment of rising prices and interest rates which most often go together. If possible, seek advice from an experienced financial advisor or investment consultant. Reduce exposure to assets or instruments that will suffer the most in the environment of high inflation such as fixed-interest bonds and richly valued growth stocks and raise exposure to instruments like floating rate bonds and high yield stocks.
3. Rework your financial goals. If you are saving and investing to fulfil or fund a long-term financial goal such as early retirement, child marriage, overseas higher education or big-ticket purchases such as a house, it’s time to have a relook at those goals and their time frame. If you work with a financial adviser, then request him to rerun your goal projections using a higher inflation rate. Most investment models, for instance, assume a 4-5 percent inflation rate over the longer term, which may be too low and expected return from the portfolio may turn out to be inadequate. The review may suggest that you either top up your existing portfolio or modify your long-term financial goals.
4. Don’t get rid of stocks. In general low inflation is good for stock prices and vice versa. Not surprisingly, the equity market has been in turmoil in the last few months. So in the era of high inflation, one should reduce exposure to equities and hold physical assets whose prices will rise with inflation. But this doesn’t mean getting rid of equities altogether.
So it’s advisable to keep some exposure in good quality exchange-traded funds (ETFs). This also ensures that you don’t have to bother about timing the market when the inflation cools down leading to a surprise rally in the equities.
If you are direct investors, invest in the stocks of material or energy producers that see a sharp rise in the price of their products and thus their earnings due to inflation. You can also invest in companies with monopoly positions in their industry and thus have the ability to pass on the price rise to their customers and thus protect their margins and earnings.
5. Buy unique or tough-to-duplicate products: When inflation hits the biggest price rise occurs in products that are unique and cannot be easily duplicated. Given this, the key to prospering from inflation is to buy items that have some scarcity value such as land or top-quality homes at a prime location, jewellery and precious metals or even unique works of art. This also applies to general household goods such as furniture and consumer appliances. Items made with rare or expensive materials such as hardwood or long-lasting metals will keep their value or even rise in price during high inflation, while those made with common material will lose value. In other words in the era of high inflation buy few items but buy good ones.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).