Inflation erodes returns, but don't stop investing
DNMUM248695 | 7/2/2012 | Author : Nupur & Neelasri Barman | WC :511
You will find this hard to stomach: if you invested in a fixed deposit that offered you interest at 8.5% annually over the last five years, you would have lost over 40%.
What gives?
It's that old scourge — inflation — at work.
Say you parked `10,000 five years back in a fixed deposit, at 8.5% interest, it would have fetched you `15,036 at maturity.
Meantime, inflation based on the consumer price index has risen a whopping 60%.
Factor this and you are left with a paltry `6,014 (`15,036 less 60% inflation).
Forget gains, adjusting for inflation, your capital has eroded by 40%.
And we aren't even considering the taxes you would need to pay, depending on the income bracket you are in. Your money wil
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l shrink further once the interest you earn is clubbed with your income and taxed.
So would you rather have invested in equity?
Say you put that `10,000 in an index fund that tracks the BSE Sensex.
The index has given a 22% return in the last five years.
So after five years, you would have got back `12,200.
Factor in the 60% inflation and what have you? Just `4,880 (`12,200 less 60% inflation) — there, you have lost over 50% of your capital.
So where are the gains?
"Inflation has been so high that none of the financial instruments is able to match up in terms of returns," says Suresh Sadagopan who runs Ladder 7 financial advisory.
So where should you have parked your money?
Gold, one can say with the benefit of hindsight. The precious metal has been the real star in the last five years.
Money invested in bullion five years ago would have fetched you a staggering 226% return.
But then, experts typically recommend a 5-10% allocation to gold.
At that rate, despite the huge appreciation it fetched, the money you put in gold wuldn't quite have pulled your portfolio out of the red.
Indications are, the going will remain tough for a while more, with no letup in inflation just yet.
"Inflation may continue to be high going forward, which will result in income levels coming down, consumption levels rising and savings going down further," said Anjali Verma, economist, MF Global.
Headline inflation, or inflation based on the wholesale price index, came in at 7.55% for May.
CPI inflation, for industrial workers, weighed in at 10.22% for April.
"CPI inflation is expected to hover in the range of 9-10% in the next three months and then start falling as food prices come down," said Madan Sabnavis, chief economist, CARE ratings.
So should you stop investing and start spending?
No, say experts.
"These are trying times, when inflation continues to wipe off your returns. But this should not deter you from continuing to invest as per your asset allocation," said Amar Pandit, CEO of My Financial Advisor.
Sabnavis concurred. "Right now, due to high CPI, people are spending more on consumption and less on investments. Once CPI starts falling, people will start investing."
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