Investment risk management - how to manage risk during inflation

Is inflation eating into your investment returns? We discuss some risk management measures that can make your investment portfolio inflation-proof.

How to safeguard your investment portfolio from inflation?

Inflation is a silent monster that reduces the purchasing power of your money. For example, if your child’s school fee is Rs 50,000 this year, at 10% inflation, it will be Rs 55,000 next year. If you have accumulated Rs 50,000 for next year and kept it in a savings account yielding 3% per annum, you will have Rs 51,500 next year. In this case, you will have to contribute the remaining Rs 3500 from your pocket. 

Why is this so? As inflation is 10% and your return on investment is only 3%, inflation has eroded the purchasing power of your money. In this article, we shall look at some steps you can take to insulate yourself from inflation.

Safeguarding your investment portfolio from inflation

Over the last few years, the inflation rate in India has been in the range of 3%-7% a year.

Safeguarding your investment portfolio from inflation


To safeguard your investment portfolio from inflation, you should increase your investments in asset classes that have the potential to give inflation-beating high returns. At the same time, you should reduce your investments in asset classes that give returns lower than inflation.

Let us look at some investment risk management strategies.

Related: How You Can Make Rs 2.9 Crores By Investing Just Rs 5,000 Per Month

1) Reduce your debt investments
During a period of high inflation, debt investments like bank fixed deposits, debt mutual funds, bonds, etc., will give negative real returns as the inflation rate is higher than returns from these investments. So, you should lower your investments in these products to reduce investment risk.

2) Invest in equity mutual funds
Historically, over long periods of investment, equity mutual funds have given inflation-beating high returns.

Table: Nifty returns

Nifty returns


As seen in the above table, the Nifty 50 Index has given returns of 15.42% and 11.68% CAGR in the last 5 years and since inception. The Nifty 50 Index has the potential to continue giving inflation-beating high returns in the future also. To safeguard your investment portfolio, you can invest in an index fund with the Nifty 50 as the benchmark.

3) Invest in a sectoral equity fund with exposure to metals
Inflation goes up due to an increase in the cost of raw materials such as crude oil, steel, aluminium, etc., that are used in making finished products. During inflationary times, to manage market risk, you can invest in companies that make these raw materials so that you can benefit from them. You can do this by investing in a sectoral fund such as a commodities mutual fund or metals mutual fund.

Chart: Nifty Metal Index

Nifty Metal Index


The above chart shows that the Nifty Metal Index has gone up from less than 2000 to more than 6000 over the last two years.

4) Invest in gold
Gold is considered as a hedge against inflation. Gold acts as a store of value when inflation is eroding the value of your money. You can invest in gold in various physical forms such as jewellery, coins, etc. These days, most investors prefer to invest in gold in digital forms such as gold ETFs, gold mutual funds, Sovereign Gold Bonds (SGBs), digital gold, etc.

Related: Should You Resort To Gold During Inflation?

5) Invest in REITs/InvITs
One of the ways to reduce investment risk during an inflationary scenario is to invest in real estate investment trusts (REITs) or infrastructure investment trusts (InvITs). These products help you manage risk by combining the benefits of debt and equity. They give regular dividends (usually quarterly) and have the potential for capital appreciation.

Chart: Performance of Indigrid InvIT

Performance of Indigrid InvIT


As seen in the above chart, in the last four years since listing (June 2017 - September 2021), the Indigrid InvIT has given annualised returns of 16% CAGR. The total return is 89%, including 49% as dividends and the remaining 40% as capital appreciation.

Related: How Debt Funds Can Beat Inflation And Interest Rate Risks?

Inflation may not be in your control, but you can manage the risk it poses to your investment portfolio by following an inflation management investment strategy. During times of high inflation, the key to risk management is reducing your exposure to a debt asset class that may underperform. On the other hand, you should increase exposure to asset classes such as equity, gold, real estate, etc., that have the potential to give inflation-beating high returns.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.


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