Inflation 101 📈
And its effect on Investments
What is Inflation?
It is an increase in the price level of goods over a set time period. With the rise in inflation, the currency in a given economy loses its purchasing power. In simple words, you can buy fewer goods with the same amount of money.
Role of Demand and Supply
Prices tend to rise when demand for a good or service rises or supply for that same good or service falls. To understand this better, let's see it with the current scenario.
During the COVID-19 pandemic, people started hoarding essential goods. Due to this there was a sudden rise in demand for essential goods. However, the supply of these goods was limited. As a result, many people had to pay higher prices for the same goods.
How Government Control Inflation?
The government controls inflation mainly by controlling demand and supply with the help of interest rates, taxes, public and private spending, etc. (Monitory and fiscal measures).
A higher interest rate makes borrowing costly and motivates people to save more and spend less. Similarly, higher tax rates reduce take-home income of an individual, which in turn reduces spending.
How it affects our investments?
The rise in inflation puts an additional burden on your savings as well as investment.
It eats away your saving account balance, as the inflation rate in India is around 5% (real rate of inflation even higher), whereas, the interest rates offered by bank on savings account are 3% to 4%.
As the inflation increases, the price of bond decreases, as the bond which earns you a fixed return through interest payment loses its purchasing power with a rise in inflation.
Historically, gold has been used as a hedge against inflation. When the inflation rates rise, the value of the currency decreases. As a result, investors choose the safe haven (commodities, such as gold and silver) that can earn higher returns.
As inflation rises, the price of real estate also rises, as property owners often increase their rent when prices of goods and services are rising.
💡 Diversify your portfolio in such a way that it exceeds inflation in the long run. It is always good to start with SIP in mutual funds and companies that are fundamentally strong.