While investing many investors skip inflation adjustment which is why the real return of their investment never equals the return on paper. The reason is simple, inflation reduces the purchasing power and thus the return also decreases in real terms.

For instance, if the inflation is 4% in India, and your investment is generating 10% per annum, then the real return on your investment is approximately 6%. This is the important aspect investors need to consider while choosing any investment option.

What is inflation? How it reduces the return on investment?

Inflation is the general price rise across an economy. It is when the same amount of money you spend but in return, you get less amount of goods or services. For instance, the current inflation rate in India is 5.59% as on July, 2021 which means your purchasing power has been reduced by 4.89%. In simple terms, inflation is the percentage increase in the overall prices of goods and services.

Inflation thus reduces the returns on your investment as well because the value of money only decreases over time. Government adopts multiple policies to check the inflationary increase in an economy.

Inflation-adjusted return is the rate of return on the investment from which the inflation has been deducted. This can help you plan your investment more wisely. Suppose you need a return of 15% per annum for the next three years to accumulate a certain amount of money for a specific financial goal. So, you chose the scheme which has consistently provided an average return of 15% over the last few years. However, if you skip calculating your inflation-adjusted return, your purchasing power would decrease due to inflation, and again, there would be a gap in your required capital.

Even if the rate of inflation drops, the effect remains on the return on investments. So, as an investor, you need to calculate and anticipate the inflation-adjusted returns to get the real return on your investment.

Inflation-Adjusted Return

The question is how to invest or where to invest so that you generate a return that can beat inflation, isn’t it? Amongst all other asset classes, gold is one such asset that can generate higher inflation adjusted returns over longer time frames.

Additional Read: How Wealth Management Can Help You Plan for a Secure Retirement

Can an investment in gold beat inflation?

As mentioned above, gold is considered to be one of the most effective hedging products against inflation.

The table below shows the price movement of gold for almost 30 years and then the rate of inflation in India.

Source: https://goldprice.org/spot-gold.html

In the last ten years itself, the price of gold has doubled itself, while inflation has come down from double digits to a single digit. The annualized return of gold in rupee terms has been around 10% CAGR over the last 30 years. In the last decade itself, it was 11% while the CPI index was approximately at 6.3% (compounded). Thus, it is evident that gold can act as an effective hedge product against inflation in the long run.

Another essential factor that makes gold a good investment is that it also acts as a hedge against economic crisis.. If you take the recent example of 2020, when the Nifty and the Sensex were highly volatile with the onset of the pandemic, the gold prices touched new highs almost every day during the same period. In fact, the gold price had gone up to INR 57,920 on 9th August 2020 amidst the Covid-19 crisis. The reason being gold is still considered a haven when it comes to investment.

Is it a good time to allocate more of your investment budget to gold?

The price of gold has dropped after it reached an all-time high in 2020. However, the yellow metal has again gained momentum as trading between Rs. 48300 to Rs. 49500 and it is expected that the prices can go up further by the end of this year. So, investment in gold is not only a hedge investment but also provides better returns even after adjusting for inflation over longer time frames.

Additional Read: The Value-add of Wealth Management in a Volatile Macro Climate

Conclusion

Inflation can ruin your investment returns if you do not pay heed to it. Adjusting inflation is necessary, and finding the right asset class to generate returns to beat inflation can be the best way to generate a higher return in real terms. Gold has always proved its worth in times of crisis and as an excellent hedge against inflation.

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