Arthgyaan

Supporting everyone's personal finance journey

You cannot beat inflation even with equity mutual funds: here's why

Investing in a mixed portfolio of equity and debt mutual funds cannot beat inflation in most cases

You cannot beat inflation even with equity mutual funds: here's why


Posted on 29 Jun 2021
Author: Sayan Sircar
4 mins read
📢Join 2400+ readers on WhatsApp and get new post notifications!

Investing in a mixed portfolio of equity and debt mutual funds cannot beat inflation in most cases

Inflation cannot be beaten with mutual funds

📚 Topics covered:

Equity mutual funds are widely considered to be able to beat inflation over large periods while debt as an asset class does not. But even by investing in equity funds, it may not be possible to beat inflation at all.

For any long term goal, the asset allocation will have a mix of equity and debt. Also, to manage the risk of the portfolio over time the equity component has to be reduced over time as per the right glide-path via rebalancing. Both of these effects (a mix of equity and debt and maintaining a glide-path via rebalancing) together makes it very difficult to beat inflation over the entire duration of the investment.

Related:
Inflation: the impact on your goals and how to choose assets that beat it

Asset allocation for goals

Asset allocation

As discussed in this detailed post on asset allocation, a typical proportion of long term goals will be like this based on the risk profile of the goal and the investor. We will assume the Medium risk profile for the example in this post.

Rebalancing as per glide path

Rebalancing via glide path

This post on glide-path describes how the equity portion of the portfolio is gradually brought down over time to manage risk via rebalancing.

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

A worked out example

Table of returns

This table shows the calculation of effective return using the Medium asset allocation and average equity and debt returns of 4% above inflation and 2% below inflation respectively. This is deliberately chosen to not distract this analysis with assumptions of long term equity and debt returns. The columns show

  • Passage of time in years
  • Equity and debt proportions for each year of the goal
  • Weighted average return for the particular asset allocation for that year
  • Real returns (Return-Inflation) for 3 types of investments: lump sum, a fixed SIP, a SIP increasing at 10% a year

Example

We use the table above to work out on case where a 10% incrementing SIP is created for 10 years. The corpus grows like this:

  • Year 1, SIP 1 lakh, 5% return, starting amount 0, ending amount 1.04 lakhs
  • Year 2, SIP 1.1 lakh, 5% return, starting amount 1.04 lakhs, ending amount 2.25 lakhs ….
  • Year 10, SIP 2.36 lakh, 6.8% return, starting amount 16.81 lakhs, ending amount 20.09 lakhs

We use the last column of this table to calculate IRR which comes to 4.83%. With a 7% inflation assumption, this works out to a real return of -2.17% which is there in row 10, the last column of the table under Real Return: 10% incrementing SIP. AS this table shows, with these starting assumptions (7% inflation and equity/debt returns) we need to invest for:

  • Case 1: 22 years to beat inflation for a lump sum investment
  • Case 2: 29 years to beat inflation for a fixed SIP
  • Case 3: 40 years to beat inflation for a 10% incrementing SIP

Conclusions

Case 1 shows that a long term lump sum investment (say a gift for children’s education) needs more than 20 years to beat inflation with 60% starting equity investment

Case 2 shows that a standard SIP does not beat inflation before 30 years. This will come as a big shock to many investors who believe that starting a SIP will beat inflation over time.

Case 3 shows the same result but due to an incrementing SIP, a larger amount is invested near the end of the goal which has a more conservative portfolio.

The key takeaways for investors are

  • not assume that investments will beat inflation at reasonable levels of risk
  • positive real return during retirement is not possible
  • investments should be as high as possible as per the plan of investments - this is the only way to meet long term goals
  • review and rebalancing is essential to manage risk

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

To understand how this article can help you:

If you have a comment or question about this article

The following button will open a form with the link of this page populated for context:

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Previous and next articles:

<p>Diversification is spreading risk across various investments so that all of them don’t perform equally bad (or good) at the same time</p>
Portfolio Construction
What is diversification: how and why should you do it?

Diversification is spreading risk across various investments so that all of them don’t perform equally bad (or good) at the same time

Published: 28 June 2021

3 MIN READ


<p>The Investment Policy Statement (IPS) is an important starting point of goal-based investing: here’s why</p>
Portfolio Construction
What is an Investment Policy Statement and why it is needed?

The Investment Policy Statement (IPS) is an important starting point of goal-based investing: here’s why

Published: 30 June 2021

5 MIN READ


Latest articles:

<p>This article provides a clear guide to navigating the insurance requirements when securing a home loan, helping you make informed decisions.</p>
House Purchase Loans Insurance
Understanding Insurance Requirements for Home Loans in India: What's Mandatory and What's Optional?

This article provides a clear guide to navigating the insurance requirements when securing a home loan, helping you make informed decisions.

Published: 15 May 2024

3 MIN READ


<p>This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.</p>
Behaviour House Purchase Loans
How to manage a home loan if you are worried about job loss?

This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.

Published: 14 May 2024

8 MIN READ


Topics you will like:

Asset Allocation (21) Basics (8) Behaviour (13) Budgeting (12) Calculator (25) Case Study (6) Children (17) Choosing Investments (40) FAQ (12) FIRE (13) Gold (22) Health Insurance (5) House Purchase (33) Insurance (17) International Investing (12) Life Stages (2) Loans (20) Market Data (8) Market Movements (17) Mutual Funds (47) NPS (8) NRI (19) News (18) Pension (8) Portfolio Construction (53) Portfolio Review (27) Reader Questions (8) Real Estate (7) Research (5) Retirement (38) Review (16) Risk (6) Safe Withdrawal Rate (5) Set Goals (28) Step by step (15) Tax (59)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.

More posts...

Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled You cannot beat inflation even with equity mutual funds: here's why first appeared on 29 Jun 2021 at https://arthgyaan.com


We are currently at 401 posts and growing fast. Search this site:
Copyright © 2021-2024 Arthgyaan.com. All rights reserved.