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How to avoid inflation from eroding your returns

Here are some investment strategies that help you beat inflation


   Fixed income investments are usually recommended for risk averse investors who are more concerned about preservation of capital. At the end of a two-year period, original investment will become Rs 5.83 lakhs. One needs to factor in inflation to understand Shekar's real returns.


   If the inflation rate was hovering at around seven percent, the real returns will be only Rs 10,750. This is a paltry return for a two year investment horizon. For those investors who swear by debt products, ever imagined what Shekar'e returns would be if inflation were eight percent or more? Only inflation-adjusted returns can throw light on your actual returns.


   In an inflationary economy, prices of goods and services head upwards. The official measure of inflation is the Wholesale Price Index (WPI) that is based on wholesale prices of 435 items. When locking money over a long term, investors should keep in mind that the dreaded inflation eats into your returns. So, if you are saving for retirement or for your child's marriage, ensure that the soaring inflation number does not leave you in financial trouble.


   Here are a few popular approaches to beating inflation:

Laddering    

Investors with a low risk appetite lock their hardearned money in fixed deposits (FD). Breaking a FD and reinvesting in another instrument is not without additional expenses. This technique also allows investors access to their money at short intervals for meeting their personal expenses


   In a laddering strategy, instead of locking the entire money in a single fixed deposit, it is broken into smaller portions. They are locked in different deposits having different maturity dates.


   If an investor has Rs 50,000, locking the entire amount in a 5-year FD prevents him from benefiting in a scenario of increasing interest rates. Under the laddering technique, invest a portion, say, Rs 10,000 in a one-year deposit, the next Rs 10,000 in a two-year deposit, the next chunk in a threeyear deposit and so on. Since the money matures at periodic intervals you will have lesser chance of incurring loss from premature redemptions.


   When the first year FD matures, lock it again in a five-year deposit. When the second FD matures, lock it again in another five-year deposit. Continue rolling them all over to five-year deposits when they mature.


   In a scenario of increasing rates, investors can reinvest the money that matures at the increased rate. Laddering prevents your entire money from getting locked up at lower rates, especially when interest rates are heading upwards.

Equity exposure    

Only higher returns on investments can beat inflation. It is essential for investors to build a portfolio mix of various asset classes based on their risk appetite and investment goals. Equity investments have proven to yield higher returns to beat inflation.


   Those with a moderate risk appetite can consider monthly income plans (MIPs) that are heavily tilted towards debt investments (75-80 percent) with some equity component. MIP is tailored for those individuals who regularly need money to supplement their income each month. Dividends on MIPs are taxfree in your hands unlike FDs. Due to the equity component of a MIP, the returns are higher than from traditional debt instruments.


   Aggressive investors can invest directly in the stock markets or through diversified equity mutual funds that give robust returns over a long term.

Gold and real estate    

Add gold exchange-traded funds or bars and bullion to bring stability to your portfolio in times of extreme volatility. In times of high inflation and depreciating currencies, the yellow metal has proven to yield good returns.


   Real estate is a wonderful option for investor who can lock their money over a long term. While the returns are phenomenal, liquidity is a prime concern. Both gold and real estate have historically fared well against the inflation monster.

 

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