Tanya's Inflation Journey: Beating the Price Race and Growing Wealth

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Tanya had been saving for a long time to buy herself a branded bag. She had invested in some Recurring Deposits and a piggy bank. She had her eye on one particular design and wanted to buy a similar one. When she thought she had saved enough. She broke her savings and checked the prices, only to find that the prices had gone up and she was short of a few thousand. This was the second time this was happening.

She felt dejected and decided to understand why this was happening and how to tackle these changes in price. She wanted to get to the roots of the problem to overcome it and make her money grow along with these racing prices.

Why the Race with Price?

This constant race with price is something everyone would have faced in their lives. Everything is becoming costly day by day, but the income is not rising at the same pace. This phenomenon is what economists call the “inflation”. In simple terms, inflation is the difference between how much you can buy from a certain amount of money within a period of time. That is how much your purchasing power is reduced.

Why Does Inflation Happen?

Inflation is caused mainly by these three reasons: demand-pull inflation, cost-push inflation and built-in inflation.

• Demand-pull inflation is when there are not enough products or services being produced to keep up with demand, causing their prices to increase.

• Cost-Push Inflation is where the cost of production and services rises, forcing businesses to raise their prices.

Built-in Inflation, also known as the wage-price spiral, is where the workers demand a raise to manage the rise in living standards and cost of living. This in turn causes the other two kinds of inflation.

Is Inflation a Bad Thing?

Though price is always associated with negative connotations, inflation is actually a must for growth. Inflation helps the economy of a country grow. the key is in the balance. Inflation is like salt in food, either a bit too much or a bit less can spoil the taste of your recipe. Inflation in the right percentage drives a country to development and growth. Too much inflation can drive a country into recession, and very little of it can send it into bankruptcy. The right balance keeps it going.

So inflation, as long as it’s at a walking pace, is always good. Governments and central banks of each country that regulate money ensure that inflation stays at the same pace through various actions. This will be a lesson for another time.

How Does Inflation Affect Our Investments?

So now that we have understood what is inflation let us descend to the effect it has on our investments and daily life.

Say the inflation rate is 10%. Tanya's branded bag is currently valued at 25000Rs, it is expected to increase to 27500Rs next year. So as to fight the price hike, you need an investment that gives you returns higher than the inflation rate.

Any investment that doesn’t beat the inflation rate is actually giving you negative returns, meaning you’re actually losing money. To identify this you need to understand the real interest or return rates of various investment options.

Example:

Smart Investment Options To Win Inflation

For every risk-averse investor, a fixed deposit seems to be the best bet, but inflation can hurt fixed-income securities. Here are a few other options which are too risky and also help you beat inflation.

Real estate

When inflation rises, interest rates also go high. This affects most asset classes, like certain stocks and bonds and mutual funds that have invested in these. However, real estate is an asset class that can perform relatively well during inflationary, rising-rate environments. Also, invest in commercial or residential rental properties that can generate income.

According to RBI's House Price Index, which collects real estate prices across ten cities, the average return from owning Indian real estate in the past ten years has been around 9% as of 2023.

Gold

Gold is considered to be a 'safe-haven' by experts around the world. It is the best hedge against inflation because in the past the increase in gold prices and the returns thereof have proven to offset inflation. Gold is a commodity and not a paper asset.

A study by the World Gold Council says that for a 1% rise in inflation, there is a 2.6% rise in gold demand, and a surge in demand for almost anything leads to an increase in prices.

You can buy gold in physical form, as jewellery or sovereign gold bonds issued by the government.

Inflation-Indexed Bonds

Inflation-indexed bonds (IIP) issued by the Indian government are designed to offer investors returns that outpace inflation. These bonds are overseen by the RBI, acting on behalf of the government, and they utilize an 'index ratio' to adjust the principal amount in response to inflation.

Tanya after understanding the causes of inflation and identifying smart asset classes, diversified her portfolio and invested in gold, and Inflation-indexed bonds to outsmart inflation. She also soon plans to invest in real estate. When are you starting your investment journey?