The immediate decline in the prices of the key commodities and energy has now turned into multi-decade high inflation across the globe including in India. High inflation hurts almost everyone in the economy; it's especially bad for savers and investors. A rise in the cost of living due to higher inflation lowers the purchasing power of your savings and investment.
While inflation hurts fixed income savers such as those who invest in bank and post office deposits the most, equity investors also take a hit. For example, the benchmark BSE Sensex is down nearly 5 percent since the beginning of the current year while 12-month returns are now down to 6 percent from 22 percent in the 2021 calendar year.
This is largely due to the market’s fear of inflation and its effect on corporate earnings and interest rates. A combination of a higher cost of living and poor returns from your investment portfolio is bad for your long-term financial health. That’s why it’s important to make your investment inflation-proof. Here are five ways to do it.
1. Invest in precious metals such as gold & silver. Historically precious metals such as gold & silver have been a good hedge against inflation and investment in them is a good way to protect the purchasing power of your accumulated wealth or savings.
Precious metals are also the easiest and safest way to protect your purchasing power from the corrosive effect of rupee depreciation which is quite common during periods of high inflation. This is not surprising given that both the metals are traded in US dollars rather than Indian currency.
This is especially true of gold which is also an alternative to fiat or paper currencies.
And it has worked so far. Gold prices in rupees were up 7 percent during January to June this year compared to a 9 percent decline in Sensex during the period and more than make up for the depreciation in the value of the rupee against the US dollar during the period.
2. Buy physical assets such as real estate. Inflation is good for physical assets because it raises the replacement cost of real estate assets such as homes and offices. Higher prices of construction materials such as cement, steel and labour due to inflation will translate into higher prices for your completed or refurbished house and they will act as a store of value for your wealth. This is especially true for properties with high-quality construction and good location.
This is especially advised for those sitting on surplus cash that is losing its purchasing power sitting in bank accounts with lower than inflation interest rates.
3. Invest in Real Estate Investment Trusts or REITs. If you find the direct ownership of real estate too expensive or financially risky, then you should buy the stocks of listed Real Estate Investment Trusts or REITs. A real estate investment trust is a special purpose vehicle like a mutual fund that owns and operates different types of income-generating properties such as apartment buildings, malls, offices, hospitals and hotels among others.
A REIT earns rent from its investment in these properties which it then distributes to investors or shareholders by way of dividends. Property prices and rental income tend to rise when inflation rises and that reflects in the market price and income of REITs. This makes them a natural hedge against inflation.
Also Read: Where to invest amid rising interest rates
There are currently three listed REITs in India – Mindspace Business Parks RIET, Embassy Office Park REIT and Brookfield India REIT. Two of these have outperformed the BSE Sensex by a big margin in the last 12 months. The first two also give a 5 per cent plus dividend yield on their stock.
4. Invest in a diversified equity portfolio such as an index ETF. Large-cap companies with market dominance in their industry have the pricing power to take price hikes and pass on the cost rise to their customers. They can also mitigate input cost rise through productivity improvement and product innovation. This means a minimal decline in the margins and earnings of industry leaders compared to mid and small-cap stocks during the period of high commodity prices and high inflation. Choosing the right companies to invest in is the key in times of high inflation.
ETFs also have a very low total expense ratio (TER) that translates into higher net returns in the long term.
5. Invest in commodities or commodity-producing companies. High inflation usually leads to a faster rise in the price of industrial commodities such as metals, and energy such as coal, oil & gas and food commodities. So one way to protect your investment from inflation is to invest in commodities through commodity ETFs or commodity funds that invest in commodities on behalf of their investors or unit holders. Commodities also tend to be uncorrelated with the stock market which adds a diversification benefit to an investor’s portfolio.
Alternatively, you can buy the stocks of leading companies that produce these essential commodities. Higher commodity and energy prices translate into higher margins and profits for commodity producers and their stock rallies. A jump in their earnings also induces them to pay bigger dividends that can be a good source of income for the investor. Tata Steel, Vedanta and JSW Steel, for example, paid record high equity dividends in FY22. This also translated into a very high dividend yield for these stocks.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).