Inflation is one of the major reasons why everybody keeps telling you to not just save but make inflation beating investments. Inflation, or the general increase in prices of certain important or necessary items, is on the radar of our central bank as too much of it makes living, literally, dearer for everyone.
You as an investor need to keep this in mind when planning your investments. But there is something we all need to consider first.
Do we need to consider inflation for all our investments?
The answer depends on what is the aim behind your investments.
In the short term
In the short term, the important thing is the safety and security of your savings. Even more than the impact of inflation. Whether your investment beats inflation or not is really a moot point, when it comes to a period less than 3 years.
Inflation has a significant impact on the purchasing power of money only over the long term, which is three years or more. So imagine if annual inflation is 5%, Rs 100 at the beginning of the year becomes ~ Rs 95 by the end.
Money in the bank earns a bare minimum of 4% these days so technically the Rs 100 has become Rs 104 and its true value is Rs 98. In case of a Fixed Deposit or a Debt Fund, with returns being in the 6.5% , you would have Rs 106.5 at least, which is actually worth Rs 101.5, considering the impact of inflation.
If what you plan to use your investments for is not going to become dearer by the inflation percentage by some margin, then beating inflation is not necessary. Having the money when you need it, and the certainty of it, is definitely a necessity. This is why investing for short term needs means investing in more stable investments such as fixed deposits or Debt funds.
In the long run
In the long run, or over three years, however, inflation can have a significant impact. If you think about it, even anecdotally, people talk about how things were so cheap when they were children, and not a couple of years ago!
A 5% inflation can drive the value of Rs 100 to Rs 50 in less than 15 years. At the very least you want the purchasing value of that Rs 100 to remain Rs 100.
In such a scenario, beating inflation is an essential requirement for any investment deserving of your long term money. This has so far been done reliably only by equity as an accessible asset class. Money in a Fixed Deposit would have barely matched inflation and money in a bank would be worth a lot less.
The point is….
Short term investments get used before inflation can truly impact the purpose for which you saved. They are far more goal oriented and normally finance definite expenses.
If you are saving for a vacation abroad in 2-3 years, ticket prices and the like aren’t going to soar thanks to inflation in such a short period of time.
Retirement in 2-3 decades, though, is a goal that needs to take into account the ravages of inflation. You need a way to invest that maintains the value of your savings, and thus you need Equity Mutual Funds.