While in all other respects we are asked to focus and live in our present, when it comes to money management, there is a need to look at the future value. We all earn to satisfy our financial goals which may occur in the immediate future or over the long haul. In this context, it is important to understand the concept of the future value of your investment and how inflation impacts the value of your money. There are ways in which you can mitigate the impact of inflation tactfully. Here we discuss these aspects in greater detail.
What is the future value of money?
The current value of your assets when projected into the future is termed future value (FV). Such projection is based on a certain assumed growth rate. Future value is an important aspect used whilst financial planning. Investors and financial planners, alike use this to estimate the corpus that the investment would be worth. Typically, investments are made such as to align them to any financial goal that may arise in the future. The assumption of the growth rate on your investment is critical as it would give a sense of whether your financial goal is attainable given the investment pattern that you propose to follow. The growth rate that you assume should not only be realistic but should also take into consideration other external factors like prevailing interest rate, inflation rate and tax rate. While items like interest rate and tax rate are beyond the control of the investor or financial planner. You can mitigate the influence of inflation on your investment by prudently hedging your investment. Before we understand how to do that, we need to get an understanding of inflation.
What is inflation and how does it affect your money?
The inflation rate is a macroeconomic factor which reduces the value of your money. Now, this may seem confusing! Let’s understand this by a real-life scenario, we have all heard of our parents quoting that things used to cost a lot lesser during their time. They complain about the rising price of milk, groceries and other household items. This essentially means that the same quantum of money can successively buy a lower quantity of goods with the passage of time. This fall in the value of your money is due to inflation. This concept of inflation when extended to your investment essentially means that the rate of return on your investment should be adjusted for inflation to ensure that the corpus built will cater to the financial goal given that the financial goal is likely to be affected by the inflation rate over the time horizon under consideration.
- Inflation occurs when the money supply increases as compared to the productivity rate in the economy.
- The inflation rate is the rate at which the actual value of an investment is eroded, it indicates the loss in purchasing power over time
How to mitigate the influence of inflation?
Here are 3 ways in which you can mitigate any adverse influence of inflation on your portfolio
By diversifying across asset classes, you will be able to reduce the impact of inflation considerably. Not all asset classes react in the same way, often interest rates and inflation rates are closely associated, hence the interest-bearing instruments tend to be influenced significantly as compared to certain stocks.
- Invest in stocks of defensive sectors:
Would you stop buying your toothpaste or toothbrush when it gets too expensive? Would you refuse to take medication if the prices spike up suddenly? These are consumables and hence, are often (to a large extent) immune to inflation. FMCG and Pharma stocks are defensive sectors which work well during inflationary times.
- Invest in Gold:
Gold is considered a natural hedge against other asset classes. It is a value store. Hence, often during an uncertain macro environment, inflation rises due to a gloomy economic outlook, and gold continues to hold value. Adding gold to your portfolio will help bring the right balance to your portfolio.
Inflation is a naturally occurring phenomenon, you cannot eliminate the influence from your portfolio. However, with appropriate hedging, you can contain the impact to a large extent. Reach out to financial counsellors at TATA CAPITAL who can help you design a portfolio that will be able to weather tough economic scenarios.