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How Inflation Affects your financial Decisions

By the Paise Sherpa

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. 

     Investments

      If your Investments cannot beat inflation, your absolute Investments are increasing however the “value” or “ 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. 

      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 loosing Rs. 1000 considering the inflation.

      One of the main criteria of selecting a suitable investment option is that its rate of return should at least beat the inflation in order to grow your money. 

     Financial goals

      Long term financial goals like children's education, important events like marriage, buying the property of your dreams need to 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 the graduation program. 

     Retirement corpus

      Planning the post retirement monthly budget needs to factor in inflation. The monthly outlay will keep increasing every year. Your monthly expenses of Rs. 40000 today might become Rs. 200000  by the time you retire depending on your age and number of years of service left. With increasing life expectancy (appx 30 years post retirement that needs to be provided for during 30 years of working life), you need a substantial corpus after retirement. Also the additional medical costs post retirement needs to be factored in.

C   Clearly, inflation is an crucial factor that needs to be understood before making important financial decisions. Since the inflation affects you over a period of time (often many years), you need to factor in inflation in important financial goas like retirement planning, investments and so on. 

      

    


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