InvestorQ : Is it true that inflation has a big impact on investments over longer periods of time?
Abhi Yadav made post

Is it true that inflation has a big impact on investments over longer periods of time?

Abhi Yadav answered.
3 years ago

That is absolutely correct. Remember that inflation has the tendency to be sticky and also to keep compounding the impact on prices. Like your SIP compounds your wealth on the positive side, inflation diminishes your wealth by a compounding factor. The power of compounding works negatively in the case of inflation. Hence, over a period of time, the impact of inflation gets magnified. Also, inflation tends to be sticky, by default, and takes time and macro efforts to improve.

Remember that high inflation and equity markets have never made good bed partners. High inflation is acceptable up to a point and it is essential to support growth. But when it reaches the point of no-return like we are seeing in Turkey and Argentina; that is when the troubles begin. Inflation and equity values are normally negatively correlated. Higher inflation means higher discounting rate for future cash flows and hence lower present value. This problem is more pronounced for economies like India.

Inflation and the currency have a unique relationship. How does that work? This is a major problem for economies like India which depend heavily on foreign portfolio flows. Higher inflation means higher depreciation of the currency, which prods many fund managers to book out of such markets en masse. A major risk for sure. As the globally acclaimed investors, Ray Dalia, put it very succinctly, “There are two main drivers of Asset Class Returns viz. Inflation and Growth”. That perhaps sums it up all.