Inflation is taxation without legislation – Milton Friedman
What is inflation – Inflation is why a liter of milk costs more today than it did last month. In technical terms, it is a general rise in cost of goods and services that ultimately erodes long term purchasing power.
How it impacts your day to day life – As prices of everyday items increases and your income may not rise as much, you may have to reduce the consumption or postpone it.
Is inflation bad – Like most things in life, moderation is a key. A little bit of inflation is desirable because it means economy is growing. But rapidly rising prices can noticeably erode consumers’ purchasing power or force retirees to dip deeper into their nest eggs than expected.
What is the concern today – Today most of the countries are facing severe rise in inflation (multi-decade high) due to unprecedented stimulus by countries to fight Covid and supply chain disruption led by Russia-Ukraine war and China Covid cases.
What is RBI doing – One of the main goals of RBI is to keep inflation near control over the long term using monetary tools. Certain target is meant to keep inflation gradual and more predictable to help minimize its impact. RBI has started increasing interest rates and other measures to control liquidity.
What could end inflation – If supply chain issue resolves, prices could begin to stabilize. However, if inflation persists, RBI can continue raise interest rates to a level which will help suppress inflation.
What could happen to my portfolio – Some asset classes are more sensitive to inflation than others.
Fixed income particularly is vulnerable to rising inflation because of their inverse relationship to interest rates. As interest rate increases, the prices of debt securities fall as investors move to higher yielding one securities.
In case of Equities, inflation can be good or bad depending on the level of inflation. Low to moderate inflation is generally healthy for equities whereas hyperinflation is bad. Inflation leads to rise in raw material prices which impacts the profitability of companies. Companies which can pass on the rise in raw material prices without impacting it’s demand tend to do good even in inflationary scenario.
Commodities are real, physical assets and strong hedge against inflation as their prices define the underlying inflation. So basic resources, metals, energy, agricultural produce tend to do well under rising inflation scenario and vice versa.
Gold has the same relationship with inflation because it is also a precious metal – a commodity after all. Gold is the best inflation hedge as it tends to protect value of your portfolio in times of rising inflation.
Real estate prices also tend to rise when inflation rises as property owners or landlords demand higher returns to offset rising raw material costs. Thus, real estate is also a physical asset which has a high correlation with inflation.
And that’s why it is important to have a diversified portfolio across asset classes as it helps to reduce the volatility of your portfolio and helps to balance the risk and reward over a longer period of time.
If all this is too confusing, then give us an opportunity to help you optimize your portfolio.
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