How to potentially beat inflation with your mutual fund investment

Inflation is the gradual increase in the prices of goods and services, making your money buy less over time. If the interest earned on regular savings can't keep up with inflation, the purchasing power of your savings goes down.

To address this, investing in mutual funds can be a wise strategy. Mutual funds gather money from many investors to invest in various assets, like stocks and bonds. In the long run, the potential for better returns in mutual funds can help your savings grow faster than inflation, thereby possibly increasing your purchasing power.

• Table of contents

1. How is inflation calculated?
2. What does ‘beating inflation’ mean?
3. How mutual fund investments can help you beat inflation?

How is inflation calculated?

Inflation is usually calculated using the Consumer Price Index (CPI). Here's how the process works:

1. Selecting a basket of goods and services: A representative set of commonly purchased items, such as food, housing, transportation, healthcare, and education, is chosen to reflect typical consumer spending.

2. Tracking prices: Prices of the selected items are monitored over time, with data gathered from various sources like retail stores, supermarkets, and online platforms.

3. Calculating the CPI: The CPI is determined by comparing the cost of the basket in the current period with the cost in a base period.

4. Calculating the inflation rate: The inflation rate is the percentage change in the CPI over a defined period, calculated with the formula:

Inflation Rate = (CPI in Current Period - CPI in Previous Period) / CPI in Previous Period) * 100

Example:

If the CPI in January 2023 was 100 and the CPI in January 2024 was 105, the inflation rate for the year would be:

Inflation Rate = ((105 - 100) / 100) * 100 = 5%

What does ‘beating inflation’ mean?

"Beating inflation" means earning a return on your investments that exceeds the rate at which prices are rising in the economy.

If the inflation rate is 3% and your investment returns 5%, you're beating inflation by 2%. This allows your investment to grow faster than the rising cost of living, preserving or increasing your purchasing power.

How mutual fund investments can help you beat inflation?

There are multiple ways in which mutual fund investments can help beat inflation over the long term. The following are some of them:

Smart investing

Choosing mutual funds during inflation can be a smart option as they can give you good returns in the long term. They can grow your money over time, beating inflation and helping your investment flourish.

Diversification and growth

Diversity in mutual funds means that are relatively less risky, as the risk is spread across different asset classes. If you have a good risk-appetite, it can be a wise choice to consider equity mutual funds as have the potential to provide inflation-beating returns in long term. This way, your wealth may grow instead of losing its purchasing power due to rising inflation.

Professional management

Mutual funds are managed by professionals called fund managers who have experience in capital markets. These professionals use their experience & research input to make smart investment choices. Because of their expertise, there’s a relatively better possibility that the returns from certain mutual fund schemes may be higher than the rising cost of living (inflation). So, when you invest in mutual funds, you have skilled professionals working to help your money grow faster than inflation.

Navigating inflation

Various types of mutual funds can help you stay ahead of inflation, and they come in three different types: equity funds, bond funds, and funds investing in commodities. Mutual funds focusing on corporate and credit-risk bonds have the potential to beat inflation. They become particularly popular in high-interest environments because of their outstanding performance compared to traditional choices like fixed deposits. However, unlike fixed deposits where the returns are fixed, returns from such mutual fund products are subject to market risks.

Looking back, numerous mutual funds have demonstrated the ability to generate returns surpassing the growth in goods and service prices over an extended period. It's important to recognize that past success doesn't assure future outcomes. Nevertheless, reviewing a fund's history can offer insights into its performance. While historical data can help make an investment decision, it is still recommended that you consult a financial advisor for proper clarity on your investment strategy based on a detailed analysis of your financial capabilities.

Conclusion

In conclusion, investing in mutual funds involves combining your funds with other investors to purchase various securities, including stocks and bonds. This combination helps in distributing the risks. This further means your wealth has the chance to grow instead of losing value. Different types of mutual funds, like those focusing on bonds or corporate credit risk, can be effective in times of inflation. They often outperform traditional choices and offer higher yields and liquidity, making them a smart option for investors facing the challenges of rising prices at a higher risk than traditional products. When investing, it is highly recommended that you consult your financial advisor for detailed investment guidance.

FAQs:

How does inflation affect my investments?

Inflation can reduce your investment’s worth in the future. This means that your money’s purchasing capacity declines over time, thus reducing your ability to purchase things with the same amount as before. So, inflation affects your investments in a negative way. While you may see your investment growing over time, if its growth is slower than the inflation rate, the final amount’s purchasing power will not be the same as before.

Which mutual fund beat inflation?

Choosing a mutual fund to consistently beat inflation is challenging due to market variability. However, equity-oriented funds typically offer the potential to earn inflation-beating returns in the long term. It is also advisable to diversify across funds and asset classes to manage risks.

How to beat inflation with SIP?

SIPs in equity-oriented funds have the potential to offer inflation-beating returns in the long term. Additionally, they mitigate the impact of market volatility by averaging investment costs through rupee-cost averaging, buying more units during market dips and fewer when prices rise. Compounding further enhances growth potential, allowing investments to build over time and potentially surpass inflation's impact.

What investment is best during inflation?

Equities and equity-oriented mutual funds offer the potential for inflation-beating returns in the long term, but come with high risk and short-term volatility. Real estate also offers potential for capital appreciation in the long term. Commodities can also act as a hedge against inflation. However, since the performance on these avenues are linked to market movements and macro-economic factors, inflation-beating returns are not guaranteed. A portfolio that combines these long-term growth-oriented avenues with relatively stable traditional investments can help balance risk and return potential.

Who is benefiting from inflation?

Borrowers with fixed-rate loans may benefit from inflation because over time, their repayment amount is worth less in real terms. Owners of assets like real estate gain as prices rise. Businesses can profit if they raise prices more than costs, and governments with debt benefit since inflation lowers the real value of what they owe.

Which types of mutual funds are best for beating inflation?

Equity-oriented mutual funds have shown potential for long-term returns that may exceed inflation, offering a possible strategy for growing wealth over time.

How long should I invest in mutual funds to beat inflation?

It depends upon the scheme category, but for equity mutual funds, a long investment horizon of five years or more is recommended.

What is the role of diversification in beating inflation with mutual funds?

Diversification is key to reducing inflation’s impact on mutual fund investments. Spreading investments across various asset classes, like equities, debt funds, and gold ETFs, can balance risk and enhance return potential. While equities may outpace inflation long-term, other assets can provide stability during periods of high volatility.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.