In the last couple of years, Indian investors have had to face what they have never experienced before. Fixed deposit rates have been falling over the last couple of years and are at an all-time low. Add to that the rising inflation, which looks like it is here to stay, and you can forget growing your money. Beating inflation itself seems like an insurmountable task for investors.
This is getting further aggravated by the investment mix of most Indian investors. Indians still prefer holding a major part of their portfolio in traditional investments like fixed deposits, insurance schemes, gold and real estate. While there has been a lot of noise about retail investors investing in equities, the reality is that most investors still have less than 10% of their monies allocated to equities. As per a Reserve Bank of India (RBI) bulletin in March 2021 (estimates of household financial savings and household debt to GDP ratio for Q2 2020-21), only 6.7% of household savings are in mutual funds.
Go for equity
Given the low allocation to equity, beating inflation looks difficult. Consider a portfolio which is invested 45% in fixed deposits, 15% into gold, 35% in insurance schemes and 5% in equities. The last 10-year weighted average return for this portfolio is 6.81% p.a. as on 31 December 2021. This calculation assumes 5% return on insurance schemes. Investors lap up insurance policies, believing these will yield them 10% plus return, but these policies seldom give more than 5-6%. The 10-year return on multi-cap insurance funds during this period was 10.65% (lower than the 13.35% of the Nifty 500 total return index). Add to this, insurance and administrative costs, the net investor returns would be drastically lower. Fixed deposit rates fell from 9% in 2012 to 5% in 2021, which means that on a post-tax basis, returns were even lower than 6.81%.
Gold and real estate have been the go-to products for beating inflation. Real estate returns have been falling. The 5-year return on residential housing as per the RBI House Price Index is 6.7% as on 31 December 2019. Adding rentals, one may be able to expect 7-8% on property. In the long-term, gold has given a CAGR of 10% but investors already have a good allocation to both gold and real estate.
The best option for investors for a better portfolio performance is to invest more in equities. Had the 35% investment in insurance in the above example been shifted to equities, the portfolio return would have been 10.23% p.a. This certainly would 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 the right way. Not through adhoc investing into stocks or a basket of stocks, but with a combination of simple active and passive mutual funds. With stocks, investors find it difficult to choose the right stocks and to decide when to exit. Back-tested stock baskets look attractive, but their sustainability and the investor’s inclination to keep rebalancing frequently is doubtful. Not to mention higher taxation due to continued rebalancing. Choose the right fund and remain invested – needs to be the motto. A combination of large-cap index funds, flexi-cap funds, and mid-cap funds would work well.
Your behaviour contributes in a big way to inflation-proofing your portfolio. Frequent churning, performance chasing, and exiting at the first sign of volatility lead to sub-optimal gains. Evaluate the risk thoroughly. Products like cryptocurrencies, P2P lending, covered bonds, etc. may be high-yielding but come with high risk. Beating inflation cannot be at the cost of putting your principal at risk.
To inflation-proof your retirement corpus, consider the National Pension Scheme (NPS). People do have many reservations about the NPS since it is a market-linked product. But the equity component is what can increase the probability of building a higher corpus. For example, ₹10,000 invested every month in NPS for the next 30 years in corporate bonds (assuming 6% p.a. return) would grow to ₹1 crore and the same amount would become ₹2.26 crore, if invested in the active equity option (assuming 10% p.a. return). The active equity option along with forced disciplined investing is what works well for NPS.
Making the right financial choices is important, but the key is to have a good savings rate. This means reducing lifestyle expenses. Your monthly budget may need relooking or reworking. The aim should be to save and invest 30-40% of the take-home remuneration and limit the EMIs to 30%.