Inflation is an economic phenomenon that influences almost everything in people’s lives. Be it groceries, healthcare costs, or even investment decisions, inflation can significantly affect financial stability. SIP investments, an automated and strategic way to invest in mutual funds, are also susceptible to inflation.
As inflation rises, the purchasing power of money decreases, which means you will be able to buy less with the same amount of money you have today. An SIP investment that appears to hold value today could potentially hold less value in the future due to inflation. So, the returns on your SIP investments need to be higher than the inflation rate to maintain the purchasing power of your money.
Let’s consider an example of how inflation can impact SIP investments
Suppose an investor starts an SIP of Rs. 10,000 per month with a 10% return rate. In the first year, the investor accumulates Rs. 1,26,703. But, if the inflation rate is 5%, the value of Rs. 1,26,703 would reduce to Rs. 1,23,300 in real terms. This means that the investor’s purchasing power would be reduced by Rs. 3,403 due to inflation.
So, how can you reduce the impact of inflation on your SIP investments?
- Diversify your portfolio with equity funds
Equity mutual funds invest in the stock market and offer high growth potential. Try to create a diversified portfolio that includes a mix of equity funds. You can choose to invest in ELSS funds or more equity stocks across various sectors, such as technology, healthcare, banking, and those that have shown resilience to economic shocks.
This way, you can spread your risk and reduce the impact of inflation on your overall portfolio returns. However, make sure to research and choose funds that have a strong market reputation, proven performance, and a long-term track record.
- Invest in gold mutual funds
Gold mutual funds invest in physical gold or gold-related instruments, which can act as a hedge against inflation due to gold’s ability to retain its value during currency fluctuations and inflation. Also, investing in gold mutual funds through the SIP route helps you invest in small amounts and build a profitable portfolio in a more structured way.
Since gold prices are subject to fluctuations, it is wise to consult a financial advisor to understand how much gold you should have in your mutual fund portfolio. Ideally, it should be 5-10% of your overall portfolio.
- Keep a long-term horizon
Investing in SIPs for a longer duration enables you to benefit from the rupee cost averaging approach. Under this approach, the investor buys units of a mutual fund at different times and different prices. So, your average cost of the units purchased is relatively lower.
Moreover, a long-term horizon also helps to maximise the power of compounding. By reinvesting the returns along with the original investment, the returns start compounding, thus, significantly increasing your overall returns and balancing out inflation.
Inflation can reduce the value of your savings and investments, affecting your returns in the long term. But you can reduce its impact on your SIP investments by adopting smart and practical strategies. Choosing funds with a high potential for growth, diversifying the portfolio, stepping up your SIP over time, and adopting a long-term approach are some smart strategies you can use.
Most importantly, stay updated with the market trends and take timely decisions to capitalise on emerging opportunities and optimise your returns.