What Is Inflation, And How Does It Impact Your Investments?
The rise in prices is a big concern. The increasing inflation is a concern for all. It reduces the purchasing power parity of the individuals. It causes a fall in the investment capacity as your expenses rise.
You can easily feel the effects of inflation. It is important to have a deeper understanding of what inflation means. It is vital to help you prepare for increased expenses and manage your finances.
Understanding Inflation
In simplest terms, inflation is the rise in prices. It can be explained as a drop in the amount of money people have to spend. It shows how much the prices of a basket of goods and services have increased on average over time.
You can understand the inflation meaning from this example.
Let’s say that you could buy a cup of coffee for INR100. It now costs INR120. The prices have gone up by 20%. This is happening because the prices went up.
Changes in market prices also affect your investment. When prices go up, you have to spend more money. This rise makes it harder for you to save money.
Causes Of Inflation
Inflation is a serious concern. To understand the meaning of inflation, it is vital to understand the causes. The top causes are:
1] Due to increasing demand
It is called demand-pull inflation. It happens when supply is limited, and the demand is more. The difference between the demand and supply causes a price rise. This is one of the major reasons for this phenomenon.
2] A rise in the price of raw material
A rise in the prices of raw materials increases production costs. An increase in production cost will increase the price of goods and services. If the price rises and there is no wage rise, there will be inflation.
3] Increase in money supply
It is referred to as the total amount of money in circulation. There are chances that the money supply will increase faster than the demand in the market. Here, your demand tends to increase against supply, but since the production is still the same, they will cause an unwanted price rise.
4] Devaluation
It is the downward adjustment in the exchange rate of a country’s currency. It makes the country’s exports budget-friendly. This makes the domestic products devalued and increase their demand. This increase in demand is faster than supply. This rise in demand in the domestic and foreign markets causes a hike.
5] Increase in wages
Your buying capacity is directly proportional to your wages. An increase in wages causes an increase in production costs. Though the wages rise, there are chances that supply might not increase in proportion. The difference in demand and supply causes price hikes.
6] Policies and regulations
Policies from the government can cause inflation. Tax subsidies provided by the government for particular goods may boost demand. Costs could increase if demand exceeds supply. Unfavourable policy changes can lead to negative market situations and even price rises.
Measures Of Inflation
It is calculated based on the CPI and WPI. WPI refers to the wholesale price index, and CPI stands for the consumer price index.
CPI tracks the changes in retail prices over time. CPI helps to analyse the following:
- The real value of salaries
- Value of pensions
- Purchasing power
- Interest rates.
WPI tracks the changes in the price at the wholesale level. It measures inflation based on the prices of goods bought and sold in bulk or between organisations.
The formula for the CPI and WPI is the same. It is as follows:
CPI or WPI = (Price of the basket in current period / Price of the basket in base period) * 100
Based on this, inflation is calculated as below:
Inflation = (Current CPI or WPI – Old CPI or WPI) / Old CPI or WPI * 100
Inflation below 2% is fine, but when it goes above 4%, you need to focus on your savings.
Understand the Effects Of Inflation On Investment
A price rise is going to impact your savings capacity. But there is more to the same. The effects of inflation on different types of investments are as follows:
- Effect on fixed assets
A link between inflation and fixed assets goes in the opposite direction. You would rather have higher returns as it goes up. But the rate of interest on fixed assets stays the same over time. So, when inflation happens, fixed assets usually lose value. So, this can have a bad effect on investment.
- Effect on equity
For equity, the effect of inflation can be both good and bad. It depends on the level and nature of the same. The effect will be based on the type of industry. Hyperinflation is troublesome for a layman and can negatively affect investment returns.
- Effect on real estate investment
Real estate is a physical asset directly linked to market price movements. Rents and home prices typically increase as inflation does. This is because landlords and property owners seek larger profits to balance increased input and consumption costs.
- Effect on commodities
Commodities are real, tangible assets that are a great way to protect yourself from inflation. It is the basis for how their prices are set. Their prices are a sign that prices will go up soon. Because of this, commodities usually do very well when inflation increases and vice versa.
Tips To Secure Investment From the Effects Of Inflation
The effects of inflation on investment can be serious if investments are not planned properly. Here are a few tips that can help you to secure your investments:
- Find your personal inflation rate
Comparing your normal costs over two time periods will help you achieve this. Many of the instruments for managing expenses are available at your disposal. This will give you an idea of your disposable income for savings.
- Modify your portfolio
If inflation happens, it’s best to change your portfolio. You need to change your asset class and invest in things that can give you better returns. Make sure you put some of your money into fixed assets to keep it safe.
- Understand its effect
Investment has a different effect on each investment. When you buy stocks or market-linked options, you need to be careful. You will have more options if you have fixed assets and real estate.
- Avoid overspending
When your purchasing power declines, you shouldn’t spend more than you can afford. Putting limits on your wants is a great way to spend more money. It will help you make good use of your savings.
Conclusion
Inflation is an aspect that you should understand while investing. You should be cautious of your expenses and savings when there is such an unforeseen price rise. You can visit Piramal Finance for better information on savings and investments. Ensure to diversify your portfolio to avoid the negative effects of inflation.