What is Inflation
Inflation is the rise in the value of commodities over a period of time. It is a quantitative way to estimate the rise in day to day prices. The rate of change of inflation plays a major role in deciding our day to day activities along with our investment mindset.
Prices rise as the currency loses value, and it can buy fewer products and services. This loss of purchasing power has an influence on the cost of living for the general people, resulting in a slowdown in economic growth.
As an investor, one needs to know how these inflation rates affect our investments and how one needs to select the right investment vehicle in the times of commodity price fluctuations.
Here are 3 ways on how the Inflation Affects the Mind Set of Long-Term Investor
Ability to take Risk
When the inflation is on the higher side, investor tend to take higher risks to meet the increasing inflation rate. As inflation reduces the purchasing power of money, investors tend to take higher risk to beat the inflation.
During the course of high inflation, one may notice a spike in the stock market index. This is because,in this scenario, investors tend to shift their capital from low risk to high risks.
The main motive to move to high risk investment is gain higher returns. These are set with a target to eventually beat the rate of inflation in the long run.
Inflation when not handled properly, may eventually lose the purchasing power of the capital.
Choosing between Equity and Debt
Since equity investments tend to provide a higher returns than debt, investors tend to shift their funds to equity. In spite of these investment being on the higher side of risk, investors tend to choose in moving to stock investment.
The risk of investing in an equity is a better alternative than choosing to stay in debt and eventually inflation eating up all the capital value.
Another alternative could be selecting a ratio between equity and debt. This can be created in such a way that the ratio for equity investment is on the higher side (about 75%, depending on the risk appetite of the investor) in order to stay above the inflation rates.
Choosing between Saving Money and Investing
This is a crucial decision to be bade by the investor, whether he needs to invest the money in assets or keep it as saving. There are times where having a cash component is more beneficial than investing the money in assets.
Especially during bear market, when the economy is not is in its right shape or the country is facing war-like crisis.
Having a cash reserves also gives an opportunity to investors to buy in the falling markets and take advantage of buying assets at a huge discount.
How does Inflation Impact the Mindset for Other Forms of Investments
Real Estate Investment
Real estate investments are the most preferred form of investment till date. The reason being, physical assets yield a monthly rental income to the investors. When the rate in inflation rises, the prices of commodities also tend to rise. Thereby, increasing the prices of real estate assets.
Thus, it is not advised for investors to buy real estate in the times of increasing inflation.
These fundamentals will only be applicable for new real estate properties. In case of old / multiple owner properties, the cost of depreciation of asset will reduce the prices further down.
Gold as Investment
Gold as an investment is considered one of the best hedge for equity investment. As the investor increases his positions in equity, he needs to balance those investment with Gold.
Investing in equity are subject to market risk and one needs to properly safe guard the investment in equity instruments.
Inflation is a factor that cannot be controlled by the general public. There are many factors that drive the behavior of inflation rates. One needs to be sure to keep the return on the investment higher than the inflation rate for a long term value creation.