Equity may beat inflation but that doesn’t mean you will!

Published: January 28, 2022 at 7:00 am

Last Updated on February 12, 2022 at 6:27 pm

Most of us invest in equity (mutual funds or stocks) only for one reason – to beat inflation over the long term. Unfortunately, just because equity beats inflation does not mean we will be able to beat inflation!

Let us start from “Is there evidence that equity investments beat inflation over the long term?”. Yes, there is. There can be no guarantees but there is quite a reasonable chance that real returns from equity (after tax and above inflation) are positive.

We have discussed this before: Why should I invest in equity mutual funds when there is no guarantee of returns? Here is an extract.

Shown below are 1279 15-year S&P 500 Real TR Rolling SIP Returns. They are computed with the Mutual Fund SIP and Lump Sum Rolling Returns Calculators.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
1279 15-year S&P 500 Real TR Rolling SIP Returns
1279 15-year S&P 500 Real TR Rolling SIP Returns

Only 16% of the real returns are 0% or less. That is, 84% of the real returns are positive. If we insist the real return should be more than 4% (assuming 2% would be lost to tax and real daily inflation is 2% higher than the consumer price inflation), 67% of the above returns qualify.

In the case of India, the situation is tricky (explained in the article), so we set the PPF rate as an indicator of inflation.

15 year rolling SIP returns from Sensex Price data (+ 2% added for dividends) vs 15-year average of Consumer prices inflation vs PPF Returns

The 15-year Sensex return has almost always beat the prevailing PPF rate. However, the equity return has been falling and fluctuating. This is more than acceptable odds, but only when systematic risk management is in place.

There are two reasons why we claim: Equity may beat inflation but that doesn’t mean you will!

1:  The inflation number we expect equity to outperform is crucial. The rate at which our essential expenses increase year on year will be higher than the inflation numbers reported by the government. Then there is lifestyle creep. Due to increasing income, we tend to enhance our lifestyle proportionately. This is the reason why setting the prevailing PPF rate as inflation is reasonable.

If you set a lower rate of inflation for retirement, then your future expenses may be higher than anticipated. For example, suppose your current expenses that you expect to persist in retirement are Rs. 30,000.

After 20 years, at 5% inflation, the current expenses (excluding any new ones in between!) will grow to Rs. 80,000 (approximately). In our opinion, 5% is an underestimate, and 7% is safer to use. At 7% inflation, the expenses will climb to Rs. 1,20,000 (approximately). This is a significant difference.

At 5% inflation, the corpus required is about Rs. 2.2 Crores, and the monthly investment required is Rs. 35,000 (approximately). The numbers are from the freefincal robo advisory tool. For a full illustration, see: I am 30 and wish to retire by 50 how should I plan my investments?

At 7% inflation, the corpus required is about Rs. 4 Crores with a monthly investment of Rs. 65,000.

The equity return assumed in the above calculation is 10% (with allocation changing from 60% to 20% up to retirement – see above link). Now equity has beat an inflation assumption of 5% (or 7%), but if your expenses at the time of retirement are higher than Rs. 80,000 (at 5% inflation) or Rs. 1,20,000 (at 7% inflation) then it is a case of “the operation was successful, but the patient died” – equity beat inflation, but you did not! You will need to withdraw more from the corpus and it deplete before your lifetime.

2: The second possibility should be easier to imagine. A higher return expectation implies a lower investment. If we expect 12% (or more) from equity and only end up with 10% (or less), then the corpus is lower because of lower returns and lower investments!

For example, suppose we expect our average portfolio return over 20 years to be 10% (this means we expect a high return from equity with a higher allocation to equity in the initial years). We need to invest Rs. 58,000 per month to achieve a corpus of Rs. 4 crores.

Suppose we expect our average portfolio return over 20 years to be only 8% (this means we expect a lower return from equity and probably a lower allocation to equity in the initial years). We need to invest Rs. 73,000 per month to achieve the same corpus.

If we invest Rs. 58,000 per month and only end up with an average portfolio return of 8% after 20 years. We will be short by more than Rs. 80 lakhs. If, in 20 years, the actual inflation is lower than what we expected, then we might get away with it. If it is not and worse, if we have much higher expenses due to positive or negative lifestyle changes, we are in trouble.

So again, equity may have beat inflation, but our portfolio may not (lower corpus to combat inflation than necessary).

The higher the gap between the expected equity return and realised return, the bigger the failure. Lower inflation in future may soften the blow, but we cannot rely on this.

Achieving a real return and achieving a real return close to what we planned are two different things! Incorrect expectations also lead to a behaviour gap.

So what is the solution?

Since the future is unknown, it is better to err on the side of caution.

  • Underestimate returns from equity and fixed income.
  • Overestimate inflation
  • Invest as much as possible
  • Increase investments as much as possible each year.
  • Review return and inflation assumptions and other goal inputs (expenses, current cost) once a year.
  • Systematic investing alone is not enough. Systematic goal-based risk management is essential.

If you want to get started the right way, you can consider watching this: Basics of portfolio construction: A guide for beginners.

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)