How To Manage Your Portfolio During Inflation? (2024)

Inflation is among the most uncomfortable economic situations for investors. The future is opaque, and the only thing we know for sure is that our purchasing power will be diminished. This makes investing even more challenging as the traditional playbook of investing in the market when it’s cheap and steering clear when it’s expensive is harder to execute in an inflationary environment.

Inflation in domestic and international markets is on the rise and central banks, including the Reserve Bank of India (RBI), have little option but to hike repo rates to bring it down. Markets are volatile, and investors are seeking prudent ways to manage their portfolios during this turbulent period.

Inflation is Here to Stay

Rising inflation has been a worrying and talking point for quite some time now. Consumer price inflation stayed above 7% for three consecutive months (April to June of 2022), and indicators suggest it’s peaking. Russia’s Ukraine invasion, coupled with a hike in rates by The U.S. Federal Reserve has added to inflationary pressures and given the current state of affairs, it looks like inflation is here to stay for a long time.

To tame inflation, the RBI has hiked the repo rate for the third time and has brought it back to pre-pandemic levels of 5.40%. In its latest MPC meet, the apex bank has hiked repo rate by 50 bps, which currently stands at 5.40%. While it’s hard to forecast the future, we can at least manage our portfolios so that they are less sensitive to the direction of the economy.

Portfolio Navigation During Inflationary Times

Stay Away From Long-Duration Funds and Fixed Deposits

Inflation makes markets volatile. In such a situation, most investors get wary and park their investments in debt instruments such as long-duration funds. These funds invest in long-term-fixed-income securities with an average maturity period of more than seven years. However, exposure to long-duration funds can result in losses, as they are more susceptible to interest rate hikes.

If you seek to invest in debt funds, liquid and short-duration funds are better choices. While liquid funds invest in securities maturing in 91 days, short-duration funds invest in money market securities maturing in one to three years. As the maturity period of their core-underlying portfolio is low, they are prone to risks arising due to a hike in interest rates.

Equally essential is to keep guard against investments in fixed deposits. While fixed deposits (FDs) offer assured returns and are latent to market volatility, their real returns may be in the negative territory.

Real returns are returns you earn up and above inflation. For instance, if inflation stands at 7% and your FD returns are 6%, real returns are -1%. Moreover, interests from fixed deposits are fully taxable. This further brings down returns earned from FDs.

Avoid Investing in Stocks of Loss Making Companies and Thematic Funds

Companies under high debt find the going getting tough during high inflation. The situation is even worse for loss-making companies. A hike in interest rates results in higher cash outflow, and it is in your interest to avoid investing in stocks of such companies. Go back to the basics and evaluate a company’s financials before investing. Go through its balance sheet and see its amount of debt. If the amount is high, stay away from it.

Often, prices of thematic stocks go down during inflation. This excites investors to lap them and add to their portfolios. However, it can be costly. Themes that did well in the past may not be able to sustain themselves in the future. Hence, it makes little sense to invest in thematic stocks. If you wish to invest in stocks, look for companies that can retain the pricing power of their goods.

A prudent way to mitigate the inflation threat is to stick to stocks of large cap companies. These are dominant players in their segment and are better structured to weather the storm. Though the returns may not be stellar, yet they provide your portfolio with much-needed stability and liquidity. In comparison, mid- and small caps are a riskier bet, though they have the potential to deliver better returns than large caps.

Invest in Balanced Advantage Funds

Investing in balanced advantage funds is a good way to counter the effects of inflation and the subsequent volatility it induces. Balance advantage funds or BAFs invest in equity and debt and shift dynamically between them as per the prevailing market conditions based on a predetermined model. This model could either be trend-based or valuation-based.

If the BAF follows a trend-based model, equity exposure is reduced significantly during a market fall to prevent the gains from being wiped out. On the other hand, a valuation-based model holds low equity at peak valuation.

Irrespective of the model BAF follows, the end objective is to protect your gains and cut losses. Along with it, BAFs also cut out emotions from investing. Due to the dynamic adjustment between equities and debt, you don’t need to time the market as an investor.

Give Your Portfolio The Gold Advantage

Gold, since time immemorial, has been considered a safe haven during inflation. It is a tradable asset, which means it can be easily sold in the event of a currency’s sharp rise in value. This makes it an excellent investment to protect your money against inflation. Though gold prices have weakened, yet the yellow metal makes a strong case in point for itself to be a part of your portfolio. However, instead of investing in the metal in its physical form, it makes sense to invest in it through sovereign gold bonds (SGBs).

SGBs are a superior alternative to holding gold. Not only do they reduce the risk of theft, but also eliminate purity issues that often crop up with physical gold. Issued by the RBI on behalf of the Indian Government, SGBs are issued in denominations of one gram of gold and offer a fixed interest rate of 2.5%. It is credited semi-annually to your account.

They are tradable on stock exchanges and capital gains tax arising from redemption is tax exempted. The maturity period of SGBs is 8 years. However, if you decide to exit before maturity, you can claim indexation benefit on long-term capital gains.

Investing in SGBs can also help in capital appreciation as prices of gold tend to rise with time. Apart from SGBs, you can also contemplate investing in Gold ETFs. Just like SGBs, they weed out issues related to purity and storage. They offer greater price transparency and are quite liquid.

Diversify Your Investments

The time-tested mantra of diversification can hold you in good stead at this point. Note that the effects of inflation on different asset classes are different. Diversification across financial instruments and asset classes like equity, debt, gold and real estate can help your portfolio navigate choppy waters amidst inflation. Diversification during inflation is essential for achieving long-term returns in a low-risk manner.

Diversification is important even within asset classes. For example, if you seek to invest in mutual funds, you can choose a mix of equity and debt funds. If you can stomach high risks, you can invest in a mix of large-cap and mid-caps. If your portfolio is tilted too much towards a particular asset class, rectify the same at the earliest. However, factor in your financial goals and risk tolerance before investing, among others.

Don’t Fret and Act Under Impulse

Investors often get worried when they see inflation reports. While feeling some anxiety is normal, it’s important not to let emotions take over. Impulse decisions can lead to suboptimal results. When portfolio values rise, taking profits too early can be tempting. Likewise, when prices are falling, there may be a temptation to sell in order to avoid further losses.

However, these knee-jerk reactions can be costly mistakes. Instead of acting on impulse, you need a well-thought-out plan that considers your goals and risk tolerance. By staying disciplined and sticking to the plan, you can minimize the impact of inflation on their portfolios. Seek professional help before tinkering with your portfolio. Professional guidance can make a significant difference and prevent you from taking decisions that can have long-term ramifications.

Bottom Line

Managing a portfolio during inflation can be difficult, but it is not impossible. You will need to make sure you are aware of the different types of investments available to you and how they can help protect your money from the effects of inflation. You should also closely watch interest rates and be prepared to move your money around as needed. These tips can help ensure that your portfolio remains stable during times of inflation.