Do you want to invest but are scared to get started? It is true that investing poses different kinds of risk, such as market declines, but not investing can jeopardize your financial future. Remember your financial goals, which might be at stake if you take the risk of not investing. A major risk of not investing is the gradual decrease in the value of money.
If you keep your money in a savings account instead of investing in an option that can offer returns than the prevailing inflation rate, the value of that money may erode over time. Most people are familiar with the term inflation, but few truly grasp the meaning and causes of it. This article will briefly discuss how Inflation can affect your money and savings.
What is inflation?
You must have heard experts and economists discussing the economy’s inflation rate. While the terms might sound like something to worry about, the concept might be crystal clear if you’re familiar with the basics.
Inflation refers to the increase in the average price of goods and services in the entire country. When inflation occurs, each unit of currency in circulation becomes less valuable because it can buy fewer goods and services. In other words, the number of things you could buy for Rs. 100 a few years back will now fetch you much less due to inflation.
How can inflation affect your investments?
Inflation reduces the value of savings over time because the prices of goods and services tend to rise in the future. When saving for the future, you might wish to have proper purchasing power in the long term. But if investments are not inflation adjusted, you might find the returns do not keep pace with the price of goods in future.
The effect of inflation is prolonged. It might consume your savings or reduce your actual return on investment if the returns are not adjusted for a price rise. For example, if your bank FD provides 5% returns and the inflation rate is 6%. When your FD matures, your real returns, i.e., the return generated by the investment option minus the prevailing interest rate, will be negative, -1%.
The effect of inflation on investments depends on the investment type.
Inflation can hurt performance for investments with a set annual return, like regular bonds. Since you earn the same interest payment each year, it can cut into your earnings. For instance, ten lakhs per annum would be worth less each year due to inflation.
Inflation might have a mixed impact on stocks. Inflation is typically high when the economy is strong. Companies might book higher revenues which could help their share price. However, companies will also have to pay more for the raw materials, hurting their overall increase in profit.
Ultimately, it depends on the company’s performance whether inflation can hurt a stock.
On the contrary, historically, precious metals like gold do well when inflation is high.
Finally, some investments like annuities are indexed for inflation risk. They provide a higher annuity income when inflation increases and less when inflation decreases.
How can you plan for inflation?
Inflation is one major reason many people don’t put all their money in the bank, as the value of those savings erodes with time.
Here are a few types of investments that investors prefer to counter a high cost of living:
Commodities such as silver and gold are often seen as a hedge against inflation. The prices of these materials tend to increase when inflation rises.
Higher-growth investments like equities, some of which include individual stocks, mutual funds, and ETFs, typically outpace inflation in the long run, so allocating a certain amount of assets to the bucket is always a sound choice.
Wrapping up
Inflation is a market force which is impossible to avoid. The impact of inflation on investments and savings can be reduced with proper planning and a substantial investment strategy in place.
It is important to remember your long-term financial objectives can only be achieved with investment.
