We’ve all heard parents and elders say “in our times milk used to cost mere Rs. 5 a liter or petrol was Rs. 20 a liter". We have all blamed the greedy grocers, shop owners or governments for your ever increasing general expenses for necessary purchases. However, what really caused the price to rise? The answer is inflation. Not knowing inflation and how it affects you could be seriously harmful to your financial, mental and even to your physical health.
Inflation is the general rise of prices of goods and services in an economy. The main reason of inflation is the increase in money supply and is related to the monetary policy of a country's economy. The effect of inflation is reduced purchasing power of the currency over time. This is the reason for incrementally increasing prices that are needed to pay for the same quantity of goods or the similar services over a period of years.
Let us now look at various financial impacts of inflation and care that you must take in your financial decisions.
Impact of Inflation on Investments
Investment and Inflation Impact
Let’s understand with an example how inflation eats into your fixed deposit returns. Suppose you invested ₹1,00,000 for 5 years at 7% interest:
| Fixed Deposit (No Inflation) | Fixed Deposit (Adjusted for Inflation) | |
|---|---|---|
| Expected Return in 5 years | 6.5% | 6.5% |
| Inflation Rate | 0% | 4% |
| Net Return in 5 Years | 6.5% | 2.5% |
| Investment Amount | ₹ 1,00,000.00 | ₹ 1,00,000.00 |
| Maturity Value | ₹ 1,37,008.67 | ₹ 1,13,140.82 |
| Total Returns (A) | ₹ 37,008.67 | ₹ 13,140.82 |
| Applicable Tax Rate | 10.0% | 10.0% |
| Tax Payable (B) | ₹ 3,708.0 | ₹ 1,316.0 |
| Post Tax Returns (C = A - B) | ₹ 33,300.0 | ₹ 11,824.0 |
Consider an inflation of 6% and you make an investment of Rs. 100000 which is giving a return of 5%. In absolute terms the return is Rs. 5000. However in real terms, you are actually losing Rs. 1000 considering inflation.
If your investments cannot beat inflation, your absolute investments may be increasing, but the real value (buying power) is reducing. Simply put, you are actually losing money. Your investments should at least beat the inflation rate, which in India has hovered from 4-6% for the past few years.
📌 Related Reading: Are Savings and Investments the Same?
Inflation and Financial Goals
Long term financial goals like children's education, important events like marriage, or buying property must be calculated with inflation in mind. Always remember that the value (purchasing power) of money will gradually decrease over a period of time. If graduating from a good educational institute costs 10 lac today, it will probably cost 40 lac 18 years from now when your child reaches college.
📌 Related Reading: Financial Planning 101: Setting SMART Money Goals
Inflation and Retirement Corpus
Planning the post-retirement monthly budget needs to factor in inflation. The monthly outlay will keep increasing every year. For example, your monthly expenses of Rs. 40000 today might become Rs. 200000 by the time you retire, depending on your age and years of service left. With increasing life expectancy (approx. 30 years post retirement that needs to be provided for during 30 years of working life), you need a substantial retirement corpus. Medical costs post retirement also need to be factored in.
📌 Related Reading: Why Building an Emergency Fund is as Important as Insurance
FAQs on Inflation
Q. What is inflation in simple terms?
Inflation is the rise in prices of goods and services, which reduces the purchasing power of money over time.
Q. How does inflation affect investments?
If your investments don’t beat inflation, you may see growth in numbers but lose real value in terms of purchasing power.
Q. How to plan for inflation in financial goals?
Always adjust your projections for education, marriage, and retirement by assuming a 5-6% yearly rise in costs.
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