Friday, August 19, 2016

How you can beat Inflation

You can do precious little to stop prices of products and services from rising. But you can insulate yourself against this rise by either cutting down on your consumption or saving enough to be able to afford these products and services in future. Investors saving for long-term goals such as their children's education and marriage and their own retirement should remember that a 100% debt based portfolio will never be able to beat inflation. In the past 10 years, the CPI for urban consumers has risen by an average 8.07%.This means investments that offer less than 8% returns have not been very lucrative. Eroded by inflation, the purchasing power of the maturity corpus is less than that of the principal at the time of investment (see graphic).

 

The only way to beat the incessant march of inflation is to invest in instruments that offer higher returns. Stocks and equity-oriented funds have a good long-term record of beating inflation. In the past 10 years, equity funds have delivered 12-15% returns, while equity-oriented balanced funds have given 10-12%. These investments are also very tax friendly, with no tax on long-term gains if the holding period exceeds one year. The tax advantage that stocks and equity funds offer is phenomenal. There is no other asset class that can give you similar tax advantage.

 

Keep in mind though that this is past performance--there is no as surance that it will be repeated in future as well. If your risk appetite is lower, monthly income plans (MIPs) from mutual funds can be a good alternative. These funds put only 15-20% of their corpus in equities and are therefore less volatile than equity or bal anced funds. However, the returns are also lower than those of equity funds. In the past 10 years, MIPs have given around 9%. Inves tors should also note that the returns from equity and balanced funds are tax free after a year, while the gains from MIPs are taxed at 20% after indexation benefit.

 

On the other hand, the maturity corpus of life insurance plans is tax-free but the returns are so low that they can't beat inflation. Tra ditional life insurance plans offer barely 5-6% returns, but investors tend to fall for the enormous maturity corpus projected by the agent. A maturity corpus of `30 lakh might seem like a big amount today, but 8% infla tion will reduce its purchasing power to bare ly `4.5 lakh in 25 years.






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