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How to invest against Inflation

What is Inflation?

Inflation is the rate at which the prices of goods and commodities are rising and thus in turn the rate by which the value of the currency is falling. To put in simpler terms – “prices of goods you purchase are rising and thus you can buy less with the same amount of money

Why is it rising?

There are multiple reasons driving this spike. The biggest of the lot is pent-up demand and loose monetary policy. 

Let’s try to understand the cycle in simpler terms.

Central Banks (RBI as in India and Fed in the US) are buying bonds(releasing cash to the economy) and depositing money in accounts to ensure post-pandemic recovery. -> The demand for goods increases and thus so do the prices. -> Inflation rises and the value of currency drops.

inflation

How does it affect my investments?

Fixed Income Debt/ Bonds

Long-term bonds are most impacted by changes in inflation. Rising inflation is the indicator that the central bank would go ahead and tighten the loosen economy by increasing the interest rates. This increase would in turn severely impact the long-term bond value. Learn more about the bond valuation and how the change in interest rate affects its yield.

To avoid uncertainties around inflation, it is advised to move away from long-term bonds and maybe look into short-term or inflation hedged alternatives.

Equity Market/ Stocks

Equity market response depends heavily on the company’s ability to pass on increased input goods prices to consumers. Consumer staples(goods consumers would buy irrespective of prices) industries would have relatively less inflation impact. But, most of the industries would fall on the other side of the story. The biggest caution would be on the “growth” companies, whose valuation is highly dependent on future cash flows. 

How can I earn with Inflation?

Real Estate

Real estate is deemed as one of the best hedges against inflation for ages. Why? – Answer is relatively simple – the rental income from the real estate would rise from year to year and thus would relatively cover for the abnormality in the inflation rate. One can get exposure to this class either through private investment(buying and maintaining properties) or investing in publicly-traded REITs ( Real Estates Investing Firms) or equities of infra companies(DLF etc.)

Gold & Cryptocurrencies

Other popular inflation hedges are gold and crypto. With limited effect on the physical value of the asset class from a change in currency value, these are considered to be a relatively good hedge.

Please note that both of these asset classes are relatively volatile.

Thanks for Reading!

Shubham Agarwal (CFA L2 Candidate | Incoming MBA candidate at University of Cambridge, UK)

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