Can Mutual Funds Beat Inflation?

5 mins read

Inflation is similar to rust. It gradually diminishes your purchasing power. It depletes your money, leaving the same amount worthless each passing year.

While there is no way to avoid inflation, strategies to combat it may not appear to be a significant issue for a year, significantly influencing long-term finances. For instance, if you put in a bank deposit that earns 9.5 per cent per year and inflation is 7%, your actual or net saving is only 2.5 per cent (return of 9.5 per cent – inflation of 7 per cent). If your child’s school fee in class 1 is Rs 50,000, the same fee in class 12 will be a little more than Rs 1 lakh, assuming a 7% inflation rate. Similarly, saving Rs 10,000 now will only be worth Rs 2,584 after 20 years.

One of the most fruitful ways to battle inflation is to invest in long-term equity mutual funds. Essentially, one must choose investment options that have the potential to generate a significantly greater rate of return to compensate for the inflationary decline in purchasing power and hence savings. Three reasons explain why they may be your best chance against inflation.

You might be a person who likes to delegate some of the growth tasks to your money. However, if your money is not generating enough to keep up with inflation, you may lose money. Inflation is the steady increase in the cost of goods & services over time, which can erode your savings.

The Federal Reserve strives to manage inflation at or below 2% per year.

1 Keeping this in mind, your assets should generate at least that much (or more) to maintain their worth. Discover how to combat this value thief with mutual funds and exchange-traded funds.

Your Money and Inflation’s Average Rate

The Consumer Price Index (CPI) indicates- that inflation has averaged slightly less than 2% over the last decade. However, the inflation rate might fluctuate monthly, depending on the state of the economy. For instance, in October 2021, inflation reached 6.2 per cent, up from 2.6 per cent in March.

For instance, suppose you hold a certificate of deposit (CD) paying 1% interest and the average annual rate of inflation for the year is 3%. After a quick calculation, you can see that your money would lose 2% of its value during the term (1 per cent CD interest – 3% inflation = -2%). In other words, you’d lag as a result of inflation. Thus, how does inflation influence the value of your money?

This does not include any taxes due on interest income. Taxes, assuming a federal income tax rate of 24 per cent, would lower your nominal interest rate (before inflation) to 0.76 per cent. This would result in a -2.24 percent inflation-adjusted loss! Thus, you can save money on a CD in a low-interest market while still losing value due to inflation and taxes. Some refer to this as “safely losing money.”

For most people, a unique approach to combat inflation is earning returns that are more than the average inflation rate while still leaving some room for taxes. The most typical approach to accomplish this is to invest in a mutual fund that is a mix of stock and bond funds.

Investing in Mutual Funds and ETFs Can Help You Beat Inflation

Building a portfolio of mutual funds and exchange-traded funds (ETFs) is comparable to home construction. There are numerous ways to accomplish this. Individuals have their preferred tactics, designs, equipment, and building materials. Finally, all structures share some fundamental characteristics and function similarly.

To design a mutual fund portfolio that can grow your money, you must go beyond the wise advice to avoid placing all of your eggs in one basket. A construction that will last the test of time requires a thoughtful design and a solid foundation.

Additionally, you’ll need a straightforward blend of mutual funds and exchange-traded funds that works well for your circumstances. In this context, “simple” refers to a few funds that complement one another rather than a large number of nearly identical funds.

Discover How Diversification Works in Reality

Diversification through mutual funds (MF) and exchange-traded funds (ETFs) entails more than simply placing your eggs in multiple baskets. Many investors believe that diversifying their investments across multiple mutual funds results in a diversified portfolio. However, “diverse” does not necessarily indicate “distinct.” Ascertain that you have exposure to various mutual funds and exchange-traded products.

For example, investing in the Vanguard 500 Index Fund Admiral Shares provides exposure to Apple, Microsoft, Amazon, and Google. You could then switch to another fund, the Fidelity 500 Index Fund. You would obtain additional shares of Apple, Microsoft, Amazon, and other companies, but you would be purchasing additional shares of the same companies included in the index.

Try the SPDR Portfolio S&P 1500 Composite Stock Market ETF to increase your diversification, which provides exposure to over 1,500 United States companies across sectors and market sizes. This wide variety can help counteract the negative impact of inflation on specific enterprises or industries by allowing others to profit from increased pricing.

Utilize Bond Funds and ETFs that Outperform Inflation

Interest rates typically rise in lockstep with inflation. When inflation increases, bonds may lose value as bond prices move opposite interest rates. However, there are strategies for investing in bonds, bond funds, and exchange-traded funds (ETFs) when inflation is rising.

Finally,

For most investors, mutual funds and exchange-traded funds are excellent strategies to beat inflation. Stock funds can provide you with higher long-term returns, as they often outperform inflation. They do, however, carry a greater risk of losing principal than bonds or bond funds.

This article should give you a good idea of inflation mutual funds and how to beat inflation with mutual funds.