Inflation & Hedges

Inflation is the rate at which the price of a particular basket of goods increases. In India, the standard benchmark used is the wholesale price inflation. The basket of goods comprises of more than 600 goods polled from more than 5000 vendors. This gives an estimate of the rate at which the price is increasing in India.

The inflation figure is calculated using the following formula

WPI = ( Price of the basket in current year) - (Price of the basket of goods in same month of previous year)

                                    (Price of the basket of goods in same month of previous year)

India has among the highest rates of inflation in Asia which is not really surprising considering that it has a rapidly growing rate of consumer base and a rapidly increasing rate of money flows. Higher the inflation, faster is the rate of loss of value of money. To make it more clear, lets assume that inflation is 10%. Suppose you buy a package of goods worth 100. Next year, the same 100 rupees will be able to fetch 10% lesser goods. Hence, it would make more sense to buy goods today than to postpone the purchase to the next year as the prices will increase by 10%. This can be offset only by ensuring that the value of money increases by a rate greater than inflation so that despite an increase in the price of good, the money does not lose value and can still buy the same set of goods. 

This is generally done by investing in places which would either beat the inflation rate or at least give rate of return equal to inflation (Generally called as inflation hedges). This insinuates the need for investing as failure to invest would make your money less valuable.

The most preferred inflation hedges are considered to be precious metals essentially because the index of inflation itself has them as major components. Besides, real estate is also considered as a good inflation hedge though it does not reflect it as well considering a huge cost of entry and also a a large amount of overheads on it. Also, it is considered that equities give inflation beating  returns as generally valuation of most companies is based on the assumption that the company will at minimal grow at rates above the inflation rate.