Inflation & asset classes

Many financial planners and even the personal finance blogs have always pointed inflation to be one of the factors responsible for destroying your wealth as well as for reducing purchasing power. In fact, you can call it as a slow poison. It reduces your purchasing power slowly and steadily. Let’s say, you wish to buy something worth Rs 1 lakh in the coming five years. Assuming inflation to be seven per cent, after five years, the same thing would be worth Rs 1.4 lakh. However, it might be opposite in some cases such as electronics. As the technology changes, they may face deflation rather than inflation. Below is a graph showing Cost Inflation Index (CII) since 1981-82:

Now the question is how different asset classes fare against inflation. Many investment veterans have always said that diversification is the main key. Never put all your eggs in one basket. No asset class work all the time. Therefore, there is no best investment or best asset classes. In different economic situations, different asset classes react differently. So, if you are invested in any single asset class then, the chances of beating inflation is low. The below graph and table shows how different asset classes fare against inflation (in this case, CII):

So, as we can see from the above table and graph, no single asset class is able to beat inflation consistently. S&P BSE 500 (representative of equity) was unable to beat inflation five out of nine times, 10-year sovereign bond (representative of debt) was unable to beat inflation four out of nine times, real estate was unable to beat three out of nine times and gold was unable to beat inflation four out of nine times. Hence, this shows that there is a need to have asset allocation in place. As said earlier, different asset class perform differently in different economic situation so, it is important to diversify your investments across these asset classes, to restrict downside risk.