Wednesday, January 13, 2010

Tips to tackle Inflation

Inflation as we have discussed, is bad. It affects your buying power as well as it hurts your investments. This is because, the interest on your investments is now worth less than what you were expected to get. The hardest hit are the retired people, who are risk averse and have most of their investments in fixed income instruments.

Inflation adjusted rate: ((1+i)/(1+r))-1 x 100

Here, i is the interest rate and r is the inflation. Thus, an interest rate of 10% would reduce to 3.77% if inflation is 6%.

Here are a few tips to leash the monster called inflation:

  1. Choose investments with returns greater than the rate of inflation.

  2. Select investments with tax deferral of contributions and earnings.

  3. With many retirements now lasting 15 to 30 years, retirees should choose investments that will hedge against inflation. The best ones would be capital indexed bonds, whose returns are linked to inflation.

  4. Look for instruments with highest interest rate and shortest maturity.

  5. Review the limits of your insurance coverage’s periodically, especially homeowners, renters, and umbrella coverage.

  6. Don’t buy into the argument that it is better to borrow and spend money now, paying the debt later with “cheaper” money.

Fixed Income Laddering - This is an inflation tackling strategy where one invests in fixed income securities over fixed periods. Equal amounts must be put in fixed time intervals (for example 2, 3, 5 year FDs). It gives you:

  • a steady income stream

  • money that is not locked for long durations (gives you the ability to invest in better returns options)

  • freedom to adjust your investments as per the financial and market situation.


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