Sakina, a college-going teenager, had saved ₹15,000 from her pocket money and the gifts she had received for her birthday. She was keen on purchasing the latest mobile handset. However, her mother asked her to refrain from doing so and to open a fixed deposit instead. “After a year, the value of your fixed deposit will be about ₹16,000.
From that, you will be able to purchase the handset of your choice and also a branded shirt,” her mother advised her. Sakina, too, agreed.
After a year, she drew ₹16,000 from the FD, but the handset similar to the one she had wanted was now priced ₹17,250. Sakina was dejected. She had delayed her purchase assuming she would be able to get higher returns from the fixed deposit.
Many individuals who opt for an early voluntary retirement, struggle later. Their thought process is that they would be able to survive on interest earned, and pursue their hobbies. There is nothing wrong in pursuing hobbies, but if the expected time horizon to survive on interest is long, one should consult a professional before seeking to end a career.
Oftentimes, our investments yield returns that are less than the rate of inflation.
Like Sakina, we end up receiving more than what we had initially invested, but the purchasing power of that amount, along with the returns it generates, is less than the rate of inflation. This is inflation risk.
Non-transparent risk
Inflation risk is not transparent. We cannot see or verify the impact of inflation on our investment. Just because we cannot see the impact, it does not mean that it doesn’t exist. Also, inflation as a risk exists in the overall system.
Therefore, inflation is a ‘systematic’ risk. We have learnt about ‘systematic’, ‘unsystematic risk’ and ‘transparent’, ‘non-transparent’ risks in these columns.
Anything that exists in the system cannot be avoided. If we go out in the open during an extremely hot summer day, we are bound to get exposed to the sun’s rays, pollution, heat, and the like.
Some of it may have harmful effects on our body and health. This also does not mean we should not step out. That is also not a practical solution.
A sensible person will plan the day in a manner wherein exposure to heat and pollution is minimised. He or she may complete the work outdoors earlier in the day. Similarly, a part of the outing could be planned in the evening and work, unless urgent, could be deferred. Similarly, we can spread our investments across various asset classes such as equity, gold and debt. While all of these will be impacted by inflation, the impact on inflation will be different on different forms of investment.
Optimum way
Focus on financial goals. If funds are needed for a particular financial goal which is likely to occur in the near future, choose investment in debt. Some of the examples of debt-based investments are fixed deposits, various post office savings schemes and bonds and debentures.
Consult your financial advisor if the options confuse you. Debt mutual funds may also be an option that must be considered. However, if your financial goals are a long time away, do not go for debt-based investments as you may lose out to inflation.
Each one of us is different, hence there is no ‘one size fits all’ solution.
Invest regularly
Discipline and consistency is the key to success in all walks of life, including investment.
Consider options such as recurring deposits and systematic investment plans (SIPs). When we invest in recurring deposits or SIPs, we are investing a fixed amount regularly.
During the year, the rate of inflation keeps changing. Sometimes it is high and sometimes, low. By investing regularly, we are ensuring there is diversification across different time periods. Inflation is a ‘systematic’ risk. To reduce the impact of such risk, the best strategy is to diversify across time.
Avoiding investments all together due to the fear of risk is the biggest risk. Always invest and keep doing it regularly; but before investing, consider your financial goals and arrive at an optimum solution.
(The author is a financial planner and author of Yogic Wealth)
