Is Inflation A Friend or Enemy ?

Is inflation your enemy? Anybody and everybody can answer this question by giving an affirmative response,” Yes”. Inflation is indeed our enemy as far as consumables is concerned. So as far as food prices, cost of education, cost of medical services etc. are concerned, inflation is indeed bad. After all, rising prices indeed hit our pockets and make purchasing power of money go down. But is this logic of inflation hitting us hard applicable in all aspects of life? The answer is no. In case of investment assets, the logic works just opposite way in many scenarios. This is what investors need to understand and capitalize on. There are some asset classes which respond positively to inflation and in fact help us build wealth as the price of these assets appreciate because of inflation. Let us look at some of the investment assets that we hold in order to understand the other impact of inflation which is surprisingly positive and helps us actually build wealth.

Real estate and inflation: All those who own real estate, especially residential premises in cities, should thank inflation for making them wealthier even though it is notional wealth. With cost of construction going up, the price of new houses has gone up making old houses costlier as well. Though housing prices have gone up for other reasons as well, inflation has definitely been a major contributor. For those, who don’t own a house the act of owning a house has become tougher with passage of time. In fact, real estate in way has been largest wealth creator in India even during recessionary period which started post 2007 when equities failed did not do.

Inflation and high yield instruments: During high inflation period, financial institutions issue bonds which offer high yield. The high yield offered are offered a long period of time as well. For example, in India currently tax free bonds are being offered for a period of 20 years with the same yield. Today getting yield of 8.5% to 9% tax free is possible only because inflation is high and benchmark yields have gone up. This has forced companies and other issuers of bonds to come out with high yield bonds. So if an investor buys these high yield bonds now, he can reap on benefits of high yield even during the time when inflation becomes low. After all, the regulatory in the country i.e. RBI is also working hard in order to pull down inflation. Buying high yield quality debt during high inflation is good strategy for wealth creation.

Share prices and inflation: Companies are the biggest gainers of inflation. Moderate to high level of inflation actually helps company make good profits. This is how it actually works. From the time a company buys raw material and to the selling of finished goods, inflation makes the price of goods go up. This gestation period of conversion of raw material into finished goods helps companies reap the benefit of inflation as the price of finished goods rises. The companies which can pass on benefit of inflation to the consumer tend to gain. In the high inflation period FMCG find their share prices inching up as they can pass on inflation to the end consumers. Holding shares of the companies which can pass on inflation to the end consumer adds up to the wealth of shareholders.

Inflation and financial innovations: Inflation has been a trigger for financial innovations all over the world. The idea of beating inflation has been of paramount importance for wealth managers and to some extent for regulators as well. Introduction of inflation indexed bonds world over is a proof of the fact. The idea behind inflation index bond is to help investors beat inflation. This means that with high inflation, investors tend to get higher return. But inflation index bonds are not just helpful in

beating inflation; they also help in making capital gains for those of sell these bonds and exit. In India, this option is not available currently. While beating inflation is a challenge that investment planners work on, inflation is a double edged sword as far as investment planning is concerned. Befriend inflation to make money from it wherever it offers such opportunity. Source : Moneycontrol