Inflation is when you pay fifteen dollars for a ten-dollar haircut that you used to get for five dollars – Sam Ewing
The seeds of second world war were sown during the hyper-inflationary period in Germany (after the first world war). Inflation is indeed a big tax on savers. Well, in my family, I was the one who used to do most of the grocery shopping and bill payment. Over period of time, I have realised that we underestimate the impact of inflation. Many times, I hear people asking how much they need to invest to get 1 crore after 10 years or after 20 years. What they don’t realize that the value of 1 crore will be significantly eroded in 10 or 20 years. Hence, it is important to factor in impact of inflation in our calculations.
Do you know it would cost 6000 rs to buy the stuff that one could buy in 100 rs in 1960!
The average inflation since 1960 has been whopping 7.58%. This means that every 10 years, value of money is less than half of its original value. In last few years, the inflation has come down a bit. As a country grows, the inflation rate tends to come down. What we notice that there are few things (healthcare, school fees, lifestyle goods) where inflation is significantly higher than the CPI. Overall, going forward, an inflation of 6% looks like a good assumption for our calculations.
How does inflation impact our financial goals?
Whatever money you have, if it earns a return that is less than the rate of inflation, its purchasing power declines. If you have a financial goal is X amount today, you have to factor in impact of inflation to know how much you will need in future.
Don’t make mistake of underinvesting by ignoring inflation
In our calculations, we assume 12% annualized return. Now if we need 10 lacs today and ignore inflation, our calculation suggests a SIP of ~4400 /month will give us a corpus of 10 lacs in 10 years. However, the chart above suggests that value of 10 lacs today will remain only 5.6 lacs in 10 years. To get a corpus of 17.9 lacs (equivalent to 10 lacs today), we need to invest INR 7994 9chart below).
The key point I want to make here is:
- Don’t ignore inflation.
- Factor in inflation whenever you are setting financial goals.
- If you have cash, you must invest it in instruments that will deliver a post-tax return of more than 6%.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
If you liked the above article and would prefer to be notified when we write next, please leave your contact details below: