Have you ever saved up for something for months or even years, only to find out that when you finally have enough money, things you wanted to buy are now more expensive than before? This is the impact of inflation on your savings. Inflation refers to the gradual loss of purchasing power due to the general increase in the prices of goods and services over time.
However, it is not just everyday expenses that are affected by inflation. Even investments, like systematic investment plan (SIP) in mutual funds, are not immune to its impact. Despite being a strategic and automated way to invest, SIP investments can still fall short if the inflation rate surpasses your investments’ return rate. To put simple, if the return on investment is less than the inflation rate, your investment value will decrease in real terms.
Impact of inflation on SIP investments
Suppose an investor wants to invest in mutual funds via SIP. He starts investing Rs. 6,760 per month via SIP with an 8% annual rate, hoping to accumulate a corpus of Rs. 5 lakhs in 5 years. However, inflation also grows at 3% annually. In this scenario, the real value of this investment gets reduced by the same percentage. Thus, the investor must earn inflation-beating returns to meet the target corpus.
Dealing with inflation and reducing its impact on SIP investments
- Diversify your portfolio with different types of equity funds
Invest in SIP equity funds that offer exposure to different companies and sectors, such as healthcare, banking, and technology, to reduce the vulnerability of your investments to inflation. You can choose to invest in ELSS (Equity Linked Savings Scheme) funds, also known as diversified equity funds, which not only offer capital appreciation but also provide tax benefits.
Besides equity, try to diversify your portfolio with debt, gold funds, real estate mutual funds, and other securities. This diversification strategy helps to mitigate the effects of inflation and can enhance the overall performance of your SIP investments.
- Invest for long term
A long-term approach gives your money more time to grow and benefit from the power of compounding. Compounding allows you to earn not just on your principal investment but also on the returns it accumulates over time. This helps you increase your overall returns and balance out the effects of inflation. Sip calculator can help you to measure your sip returns according to market conditions.
SIP method of mutual funds also takes advantage of rupee cost averaging, where you invest regularly, irrespective of the market level. This strategy helps you buy fewer units when markets are high and more units when prices are low. Over time, your average cost per unit reduces, which in turn helps to maximise your potential returns.
- Step up SIP
Step-up SIP facility allows for an automatic increase in SIP instalments at predetermined intervals, thereby helping investors to adjust to inflation. For instance, if you invest in an SIP mutual fund that provides a 10% return on investment, but the inflation rate is at 3%, the net return rate is only 7%. By using the step-up SIP facility, you can adapt to inflation and increase the investment amounts accordingly to maintain the purchasing power of your savings.
To wrap up
Inflation impacts your systematic investment plan both on the way in (i.e., value of money invested) and on the way out (i.e., purchasing power of returns). So, you, as an investor, must account for inflation while planning your investment portfolio. Seek advice from a financial advisor who can help you plan your portfolio as per market trends and inflation to support your long-term goals.
