We avoid, for now, getting into a discussion on whether inflation will rise in the first place. The jury is out to deal with that topic. On our part, we unravel exactly what the rise in oil prices means to you as an individual and investor.

Home loans
At this stage it would be presumptuous and even simplistic to conclude that a long-standing oil crisis could eventually lead to a rise in home loan rates.

The home loan rate industry is very competitive and a rise in loan rates is not as imminent as it appears. Home loan companies could decide to compromise on their profit margins and keep home loan rates at lower levels. So a rise in home loan rates is not as apparent as it may seem.

But in case of a sustained rise in interest rates (possibly due to inflation), companies could at some point react by raising rates.

So if you can bear near term risk, floating rate home loans are still a good option (in any case the rate offered is lower by about 1 per cent as compared to fixed rate loans). If you cannot take any additional risk, stick to the fixed rate type of loan.

Debt funds
As we have explained, if inflation does become a problem due to the oil crisis and increased spending/investment by businesses then bond yields could rise (bond prices could fall, resulting in losses for debt fund investors). If this happens then longer-dated bonds could see sharper erosion in their value than shorter-dated paper. Therefore, it makes sense for investors to remain invested in short-term mutual funds, especially of the floating rate variety.

With the rolling 1-Yr inflation hovering around 6.3 per cent, it is apparent from the table that all debt funds are giving a negative real return (i.e. return adjusted for inflation) over 1-Yr.

Investors also have the option to invest in variable rate deposits. With variable rate deposits, the rate of return (fixed deposit rate) is reset at regular intervals to reflect market rates. So if interest rates were to rise, the rate of return on the variable rate deposit would be reset higher.

Equity funds
Inflation does not affect stock markets like it affects debt markets, in the sense that the impact is not uniform across companies. For instance, capital-intensive companies across steel, engineering, cement sectors will be impacted differently as compared to companies in the software sector. The former will feel the impact of inflation more than the latter.

For long-term investors (with a 3-5 year investment horizon) in equity funds, the corrosive effect of inflation will be easier to swallow. In fact, equity is the best foil to counter inflation. Our recommendation – go for well-managed, well-diversified equity funds that have a mix of inflation-insensitive sectors (software) and core sectors (oil, steel). It is noteworthy that unlike debt funds, diversified equity funds have given a positive real return over 1-Yr after adjusting for inflation.