Inflation generally impacts your ability to access goods and services as it reduces your money’s purchasing power. However, does it also have a bad effect on your lump sum investments? Read on to know how your lump sum investments can be affected by rising inflation.
What is a lump sum investment?
Investing in a lump sum in a mutual fund requires you to invest all of your investible income in one go instead of investing in parts by opting for the Systematic Investment Plan (SIP) option. Lump sum and SIP are modes of investing in mutual fund schemes, each suited for different investment strategies.
What is inflation and what effect does it have on your investments?
Inflation leads to a reduction in your capacity to purchase goods and services, also called your purchasing power. If a certain amount of money can get you a list of things today, the same amount would help you purchase a shorter list of things a year down the line because of inflation.
Ways in which inflation affects your lump sum investments
Here are ways in which inflation can affect your lump sum mutual fund investments:
- Reduced real returns due to erosion of purchasing power
Inflation decreases the purchasing power of your returns. Even if your mutual fund investment provides a nominal return, the real return, adjusted for inflation, might be lower. For lump sum investments, this effect is more pronounced because you’re investing a large amount at once, and inflation can gradually erode the value of your returns over time. This is especially true for debt mutual funds, which typically offer fixed interest returns that don’t adjust with inflation.
- RBI’s interest rate hikes and their impact on debt mutual funds
The Reserve Bank of India (RBI) often raises interest rates to control inflation. When interest rates rise, bond prices fall. This is important for debt mutual funds that invest in bonds. If you’ve made a lump sum investment in debt mutual funds before the rate hike, the value of the bonds held by the fund may drop, reducing the Net Asset Value (NAV) of the fund. This means your lump sum investment could lose value in a high-interest rate environment triggered by inflation.
- Impact on equity mutual funds
Inflation also affects equity mutual funds, as it tends to increase the cost of inputs for businesses, reducing corporate profitability. Lower profitability often results in declining stock prices, which in turn impacts equity mutual fund returns. However, certain sectors, like commodities or energy, may outperform during inflationary periods. If your lump sum investment is in a sectoral or thematic mutual fund focused on such areas, it might fare better than a broad-based equity fund during inflation.
- Volatility in fixed-income funds
Lump sum investments in fixed-income mutual funds can be particularly vulnerable during inflationary periods. Since the interest or coupon payments from bonds are fixed, they fail to keep pace with rising inflation. The longer the tenure of the bonds held by the fund, the more pronounced this effect will be. Therefore, lump sum investments in long-term debt funds are at greater risk of delivering lower real returns in high inflationary environments.
- Real estate and inflation-linked funds
Some mutual funds invest in real estate or real estate-linked assets, which tend to act as a hedge against inflation. Real estate assets generally appreciate in value during inflationary periods, which can benefit real estate-focused mutual funds. If your lump sum investment is in such a fund, it could potentially outperform in an inflationary environment. However, this varies depending on the real estate market and broader economic conditions.
In conclusion
Inflation can certainly have a negative impact on your lump sum investments. A solution to deal with this problem is to invest in mutual funds via SIPs so you can benefit from rupee-cost averaging and the power of compounding to grow your returns in the long run.
