Aim For A Positive Real Rate Of Return

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd

One of the most challenging aspects of your investment process is to keep up with the rate of inflation in order to protect the value of your investments as well as returns earned on it. The impact of inflation on your portfolio depends upon its composition. Unfortunately, many of us either do not recognise the threat of inflation to our wealth creation process or are not sure about the right way to tackle this threat. In an economy like ours, where inflation is persistently high, investors must realise the importance of earning positive real rate of return i.e. gross return minus taxes and inflation.

Remember, it’s actually the real rate of return that indicates whether your money is growing in value or not. Therefore, as an investor, when you keep your focus only on the safety of capital and invest a major share of your investible surplus in traditional options offering guaranteed returns like fixed deposits, debentures and small savings schemes, this important aspect of earning positive real of returns gets overlooked. Considering that most of the traditional investment options offer lower returns and are taxed at your nominal tax rate, the real rate of return usually turns out to be either negative or minimal.

While it is true that during a higher inflation regime you get an opportunity to earn higher interest from these options, tax inefficiency of returns negates that benefit to a large extent. Therefore, investing in a tax-efficient investment vehicle like mutual fund can make a significant difference to the real rate of return. If you are a long-term investor, the first step towards achieving a positive real rate of return should be to have an investment plan in place. Though it can be quite a challenge to develop a strategy that has the potential to not only withstand the turmoil in different markets but also help in tackling inflation you can achieve the desired results by focusing on correct asset allocation.

Another important step that can help you is to curb your expenditures by budgeting them. By doing so, more money will be available for investments every month. While investing for the long term, the focus should on an asset class like equity that has the potential to beat inflation. Equities also score over other asset classes as the returns are tax-efficient. Of course, when you invest in equities, you have to contend with volatility that exists in the marketplace from time to time. Therefore, you must honour your long-term time commitment and follow a disciplined approach to investing.

If you do that, equities can be an ideal choice to stay ahead of inflation and accumulate a corpus that is usually required to achieve important long-term goals like children’s education and your own retirement planning. Remember, tax efficiency has an important role to play in combating inflation for your long-term as well as short-term investments. That’s why, as an investor, you must follow a ‘tax aware’ investment strategy and hence focus on post-tax returns. While mutual funds are more tax-efficient than other investment options, you must choose the right option such as dividend or growth to get the best in terms of tax efficiency.

For example, any capital gain arising out of an investment redeemed in equity or equity-related fund after 12 months is treated as a long-term capital gain and is taxed at a flat rate of 10 per cent. However, dividends are taxed at your nominal tax rate. Therefore, if your applicable tax rate is higher, you could opt for growth option and then sign up for a systematic withdrawal plan (SWP). This would not only ensure regular payouts despite being invested in a market-linked product but also reduce tax liability. As is evident, staying ahead of inflation should be your top priority if you wish to have enough financial resources required at every stage of your life.