Equity Mutual Funds & Inflation

One factor which is directly responsible for inflation is the interest rates. Fund managers who manage an equity fund invest investor’s money in stocks through the stock markets. Though there could be several parameters that lead to the changes in the share prices, however, interest rates play a major role here. Interest rate changes correlate with the change in the inflation rate. The rise in inflation rates could typically push up the interest rates high and vice versa. Hence, an unchecked rise in inflation is not positive news for the stock price and therefore for equity funds.

For example, construction industries purchase raw materials such as cement to build residential properties. Therefore, a rise in inflation pushes up costs for the company as the price of raw materials goes up. When looking at the annual report, if the company profit fails to grow in proportionate to the cost, then the bottom line (net profit) of the company decreases. The stock price of the company reflects all of these changes and tends to follow suit accordingly. Thus, if the rise in cost cannot be passed onto the end customer, then profits fall, leading to a fall in share price.

Understanding the return on your investment in isolation does not give you the real picture. You should know the real rate of return when it comes to your equity fund. In a nutshell, you should minus return on investment from the current inflation rate to get a real return on investment on your equity fund.

Equity Mutual Funds can be one such instrument that has potential to provide long term risk adjusted returns. It is important to understand the equity fund. Equity mutual funds are more of a long- term investment option, at least a period exceeding 5 years. Since historically, equities as an asset class are expected to give risk-adjusted returns over a long period. Equity fund taxation is based on the capital gain and the duration of holding. If the holding period is less than a year, then short-term capital gains are taxable at 15% whereas if your holding period is greater than a year, then long-term capital gains are taxable at 10%. As an investor, you might prefer a hands-on approach, but you need to have the expertise and more importantly the time to manage your portfolio. In such a fast-paced world, you may wish to outsource your stock-picking process to a qualified fund manager by investing in scheme he or she is managing. If you do have the time and resources, then maybe you can invest in equities directly. For those of us who don’t – investing in equity mutual funds could be an option to consider since a mutual fund involves professional Fund Managers managing your money, therefore potentially reducing the chances of making a wrong call on a stock.

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