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Equity can protect you from inflation

A couple of weeks ago, I wrote about what I called investment advisers’ one crore problem. Savers keep asking for a magic formula that will enable them to save Rs 1 crore over some arbitrary time-frame. Dhirendra Kumar writes.

india Updated: Aug 12, 2012 21:14 IST
Dhirendra Kumar

A couple of weeks ago, I wrote about what I called investment advisers’ one crore problem. Savers keep asking for a magic formula that will enable them to save Rs 1 crore over some arbitrary time-frame.

However, apart from the overly specific investment advice people seek, there’s also the problem of the target amount itself. One crore is generally just shorthand for saying ‘a round number that sounds like a lot of money’.

The deeper problem here is the inability to account for inflation. People think in nominal terms and the future impact of inflation is awfully hard to internalise. The real solution to this is that we should become a low-inflation economy but since that’s clearly not on the agenda, savers should always adjust for inflation.

If R1 crore sounds like the kind of money you’ll want twenty years from now then you’ll actually need to have about Rs 4 crore. If you work backwards from there, you’ll need to save about Rs 68,000 a month if the returns are 8%. By the way, if you don’t already use it then google ‘rule of 72’, which makes quick and rough calculations of this sort easier.

That’s a depressingly large amount, but there it is, there’s no escape from the arithmetic. What that actually tells you is that over long periods of time, you need a form of investment that’s inflation adjusted. That equity is risky is drummed into all investors.

However, it takes just a little thinking to figure out that inflation is riskier. And to match inflation, and to get real returns on top of that, you have to latch on to something that goes up with inflation anyway. This is not difficult because the value of goods, services and assets in the economy is inherently inflation-linked. And so risky or not, despite what I quoted Bill Gross as saying last week, equity and equity-linked investments are the only game in town to protect yourself from inflation.