Over the years, Indian investors have faced something they have never experienced before. Fixed deposit rates have been falling over the years and are at an all-time low. With that comes rising inflation, which looks like it’s here to stay, and you can forget to raise your money. Beating inflation in itself seems like an insurmountable task for investors.
This is compounded by the investment mix of most Indian investors. Indians still prefer to keep a major part of their portfolio in traditional investments like fixed deposits, insurance schemes, gold and real estate. While there is a lot of noise about retail investors investing in equities, the reality is that most investors still have less than 10% of their funds allocated to equities. According to the Reserve Bank of India (RBI) bulletin in March 2021 (Estimates of household financial savings and household debt to GDP ratio for the second quarter of 2020-21), only 6.7% of household savings are in mutual funds.
go for equity
Inflation is finding it difficult to beat, given the low allocation to equities. Consider a portfolio in which 45% is invested in fixed deposits, 15% in gold, 35% in insurance schemes and 5% in equities. The weighted average return for the last 10 years for this portfolio as on 31st December 2021 is 6.81% p.a. This calculation assumes 5% return on insurance plans. Investors adopt insurance policies, believing that they will give them returns of more than 10%, but these policies rarely give more than 5-6%. The 10-year return on multi-cap insurance funds during this period was 10.65% (less than 13.35% of the Nifty 500’s total return index). Add to this, insurance and administrative costs, the net investor return will be significantly lower. Fixed deposit rates fell from 9% in 2012 to 5% in 2021, meaning that on an after-tax basis, the return was less than 6.81%.
Gold and real estate have been the most popular products to beat inflation. Real estate returns are falling. The 5-year return on residential housing is 6.7% as on December 31, 2019, as per RBI House Price Index. Adding the rentals, 7-8% can be expected on the property. Over the long term, gold has given a CAGR of 10%, but investors already have good allocation for both gold and real estate.
The best option for investors is to invest more in equities for better portfolio performance. If 35% of the investment in insurance in the above example had been shifted to equities, the portfolio return would have been 10.23% per annum. This would certainly have beaten the average inflation rate of 6% by a good margin.
do it the right way
However, this equity exposure needs to be taken in the right way. Not through ad-hoc investing in a stock or a basket of stocks, but in conjunction with simple active and passive mutual funds. With stocks, it is difficult for investors to choose the right stock and decide when to exit. Back-tested stock baskets sound attractive, but their stability and investor’s inclination to keep rebalancing frequently is questionable. Not to mention higher taxation due to constant rebalancing. Choose the right fund and stay invested – should be the motto. A combination of large-cap index fund, flexi-cap fund and mid-cap fund will work well.
Your behavior makes a big contribution to inflation-proofing your portfolio. Frequent churning, chasing performance and exiting at the first sign of volatility lead to sub-optimal profits. Evaluate risk thoroughly. Products like cryptocurrencies, P2P lending, covered bonds, etc. can be high-yielding but come with high risks. Beating inflation may not come at the cost of putting your principal at risk.
To inflation-proof your retirement corpus, consider the National Pension Scheme (NPS). There are many objections among people regarding NPS as it is a market linked product. But the equity component is the one that can increase the chances of creating a higher corpus. for example, 10,000 every month investment in NPS (assuming 6% p.a. return) will increase for the next 30 years in Corporate Bonds 1 crore and the same amount will be 2.26 crore, if invested in active equity option (assuming 100% p.a. return). Forcedly disciplined investment coupled with active equity option works well for NPS.
Making the right financial choices is important, but the key is a good savings rate. This means reducing lifestyle expenses. Your monthly budget may need to be revisited or reworked. The objective should be to save and invest 30-40% of the take-home remuneration and limit EMI to 30%.
Mrin Aggarwal, Founder, Finsafe.