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6 – Simple Ways You Can Stay Ahead of Inflation and Create Long Term Wealth

Congratulations on making your first investment and getting started on the financial journey. But at the time of making the investment, always ask yourself – Does this investment create wealth or destroy it?

Because every investment has a “nominal return” and a “real return”. The difference between nominal and real return is a little monster known as “inflation”. Inflation simply means a reduction in buying power of the rupee over time. 

So, while your investment grows as per the nominal return, inflation works in the opposite direction. And as a result, your wealth increases as per the “real return” of the investment and not the nominal return, as people generally think.

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Suppose you invest in an instrument that gives an 8% return. So, the nominal return here is 8%. Let us assume that the inflation during this period is 6%. The formula for arriving at real return as {(1+ Nominal Return)/ (1+Inflation Rate) – 1}. So, in this case, the real return is {(1+8%)/ (1+6%) – 1} = 1.89%.

So, if you want to create wealth, you need to ensure that your investments beat inflation. In other words, they must generate a “positive” real return. An investment that doesn’t do this ends up destroying your wealth.

This article lets us look at six simple ways to stay ahead of inflation and create long-term wealth.

Peer to peer lending platforms:

These online platforms connect people who need money with people who need extra income from their surplus funds. The return from these platforms’ investments can be substantially high (around 15-25%) and therefore beats inflation by a good margin (for reference, retail inflation in India in January 2021 stood at 4.06%). You can also consider investing in good chit funds. However, don’t forget to perform adequate due diligence before investing.

Equities/Equity Mutual funds:

Equity has been the best performing asset class over long periods. BSE Sensex has given over 15% returns, year on year, since its inception in 1979. You can invest either directly in stocks or invest via the mutual fund route. You need a demat and trading account and decent stock-picking skills to invest directly. In contrast, if you invest in equity mutual funds, you don’t need a demat and trading account. Plus, if you invest in mutual funds, you can benefit from the fund manager’s professional expertise for a small fund management fee. You can also choose a systematic investment route to help you build a regular savings discipline.

Inflation-indexed bonds:

These bonds are issued by RBI and distributed by banks and financial institutions from time to time. They protect both your principal and interest amount from inflation. The interest in these bonds is linked to the Consumer Price Index (CPI). It comprises two parts – a fixed part (usually around 1.5%) and a variable part: the CPI-based inflation rate. The bonds are issued in the form of a Bond Ledger Account. One drawback is that you need to open a Demat account to purchase these bonds.

Gold and Real Estate:

Traditionally, gold and real estate are considered as a hedge against inflation. They also share a low negative correlation with equity as an asset class. For this reason, you should have some amount of gold and real estate in the portfolio as it helps to ensure your portfolio from the risk of inflation.

Small Savings schemes:

Another good option is to invest in high return small savings schemes. The interest rates and other features of these schemes are decided by the Government, so as an investor, you can rest assured of your money’s safety in such schemes.

A diversified investment portfolio:

Many investors make the mistake of sticking to only “safe” fixed-income avenues. As a result, their investment portfolio decreases in value (in real terms) over time. That’s why it is essential to follow an asset allocation. It helps diversify your investment across asset classes like equity, fixed-income and commodities in a pre-set ratio. That way, the portfolio gets the twin-benefit of stability (through fixed-income investments) and an inflation-protection (through equity and commodity investments)

Conclusion

To create long-term wealth, you need to invest in the best investments that earn a high “real return”. However, only investing is not enough. You need to diversify your investment in different asset classes and periodically re-balance it to align with the asset allocation. This will help your portfolio stay inflation-proof at all times and help you generate real wealth over the long term.


Author Bio: Aatish Khanna | Content Marketing |Money Club

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