How Does Inflation Affect Your Investment Portfolio?

The recent inflation spike in July 2023 from 4.87% to 7.44% hurt all our wallets, raising prices across the market while sapping us of our purchase power.

As an investor, it’s likely that the thought of adjusting your investment portfolio crossed your mind. After all, you don’t want your investments to lose value in the face of skyrocketing prices.

But should inflation dictate how you invest? Well, here’s all you need to know.

The impact of inflation on your investment portfolio

Inflation will undoubtedly impact your investment portfolio. However, it affects different asset classes in different ways.

1. Impact on equities:

Equities, or stocks/mutual funds, have a sort of love-hate relationship with inflation.

Modest inflation i.e Slowly climbing rate of inflation over a period of time ,usually in single digits; can be indicative of a growing economy, leading to higher corporate revenues and profits. In such scenarios, stock prices might rise.

However, runaway inflation, indicated by an upward price spiral, can increase production costs, squeeze profit margins, and erode consumer purchasing power. This can lead to declining corporate earnings and, subsequently, dropping stock prices.

2. Impact on fixed-income instruments

When you invest in fixed-income securities, such as bonds or fixed deposits, you’re essentially lending your money to the issuer. For your money, the issuer pays you a fixed income in return as interest. When the deposit matures, you get the original amount back.

These instruments are particularly susceptible to inflation. Say you park Rs. 1,00,000 in a fixed deposit that pays 6% interest, but the inflation is 7%. In such a situation, inflation has outpaced your investment. So, when it matures, your Rs. 1,00,000 would have depreciated in value due to inflation.

This is why inflation-indexed bonds were introduced. These bonds adjust their principal value with inflation, ensuring you don’t lose any money.

3. Impact on alternative assets

Real assets like real estate and commodities often act as inflation hedges, which means that in times of rising inflation, the value of these physical assets tends to increase.

For example, during inflationary periods, the price of gold—a classic store of value—often appreciates. Similarly, rental incomes from real estate might increase with inflation, making it a potentially resilient asset class.

4. Impact on international investments

Although India’s market is currently facing inflationary pressures, it doesn’t have to be the same for other countries. There is a possibility that an international market might be thriving.

This makes foreign investments a great opportunity to keep pace with inflation. However, it also comes at increased risk.

Inflationary investing–what you should do

In the short run, inflation can increase wages and, thereby, purchasing power. In fact, it can prove to be beneficial if the underlying economy is strong enough. But if the inflation continues to persist, it’s best to park your funds in safe companies and deposits to weather the storm.

You can also continue investing in equities. But make sure to target industries that fare better during inflation.

For instance, energy sector companies perform better during inflation than, say, a tech company. Why? Because their costs are tied to inflation. Consumers can avoid buying an iPhone but can’t avoid paying their utility bills.

Download the Moneyfy app or visit our website today and start investing smartly with our expert-backed strategies.