Money Matters

The right investment choice at a time of inflation

By Raeda Latif
Mon, 07, 24

Across much of the world, rising costs and inflation are prompting a major reevaluation of how people can manage their expenses while saving money.

The right investment choice at a time of inflation

Across much of the world, rising costs and inflation are prompting a major reevaluation of how people can manage their expenses while saving money.

In many cases, saving amid increasing costs is easier said than done. For most societal strata -- except perhaps the affluent -- inflation has severely diminished the possibility of savings. In fact, it wouldn't be an exaggeration to say that savings have become nearly impossible in these times of high inflation and escalating expenses.

Given the current scenario, where inflation in Pakistan has surged to 27.06 per cent for the first nine months of FY2024, the government has implemented fiscal measures such as raising and maintaining interest rates to curb money supply, reduce consumerism, and encourage savings. The current interest rate stands at 22 per cent, the highest in Pakistan’s economic history, reflecting the high-cost environment we live in today.

As a consequence of these elevated interest rates, bank profit rates have also increased, resulting in higher returns from investment instruments such as mutual funds, as well, for example. Moreover, whether through short-, medium-, or long-term bank deposits or Term Deposit Receipts (TDRs), attractive returns are available across various savings categories offered by banks.

Additionally, Asset Management Companies (AMCs) provide investment instruments, including fixed-income securities, offering returns ranging from 18 per cent to 21 per cent. These securities allow investors to enjoy substantial rates of return. However, despite the high rate of returns, the investment instruments often fail to outpace inflation. In fact, the actual returns, after accounting for inflation, often have very low to negative real value.

Consider the following illustration. Suppose the amount invested in a fixed-income security is Rs100,000. The total return on this investment at 20 per cent per annum is Rs20,000. The withholding tax (WHT) charged at the rate of 15 per cent (for filers) is Rs3,000. The net return per annum is Rs17,000. The inflation effect at 27.06 per cent* on the invested amount is Rs27,060 while the actual return per annum (net return minus inflation effect) is Rs-10,060.

This example demonstrates that the inflation impact of Rs27,060 on an investment of Rs100,000 is not covered by the net return of Rs17,000 from the assumed fixed income security. Consequently, the actual return is in the negative territory, amounting to Rs-10,060. This represents an erosion of 59.18 per cent of the net return, highlighting that post-inflation, the inflation-adjusted return is negative.

In such a scenario, it becomes crucial to explore alternative investment avenues to counteract this erosion of value. While returns from fixed-income securities are more or less confirmed, their actual returns, when adjusted for inflation, can result in a net loss. To mitigate this, aiming for investments yielding around 35 per cent or more might be necessary.

Achieving such returns requires building a smart, diversified portfolio. This portfolio may include a mix of fixed-income securities like Term Finance Certificates (TFCs), Government Debt Securities (GDS) such as Market Treasury Bills (T-Bills), Pakistan Investment Bonds (PIBs), and Government Ijarah Sukuks (GIS), as well as equities including Exchange Traded Funds (ETFs) and mutual funds. Moreover, by leveraging compounding and reinvesting returns, investors can enhance their income. Additionally, commodities like gold can further diversify the portfolio, potentially providing a hedge against inflation.

It is important to note that such diversification appeals to investors willing to accept a certain level of risk. For those with a lower risk threshold who prefer regular income, investing primarily in fixed-income securities might be more suitable.

In conclusion, if you can tolerate some risk, diversifying your portfolio with equities, mutual funds, bonds, and other asset classes can help beat inflation and yield higher income. However, if your priority is a stable, regular income guaranteed by the government, investing in government debt securities may be the best option. By carefully considering your risk appetite and investment goals, you can navigate these challenging economic times and safeguard your financial future.

The writer works for Pakistan Stock Exchange Limited.