Inflation is nothing but a sustained increase in the price level of goods and services in an economy. Moreover, various reasons contribute to inflation. One of such reasons is ‘demand and supply’ mismatch. That is to say, too much money, chasing a few goods causes inflation.
Inflation is a financial condition. It has both positive and negative aspects. Inflation is a demon who sits with you, moves with you, and at last, eats up your money. You don’t even notice it. You must have heard the story of a cat who pretends to be innocent and eats up the young birds whom a blind vulture was guarding.
In personal money management, inflation plays an important role. It is no longer a subject of commerce graduates only. You have to master it to take control of your money. Once you learn the concepts of inflation, it will empower you to save your money from the clutches of inflation.
Thus, in this lesson, we will discuss inflation and how it impacts your money, financial goal planning, and lifestyle. Let’s begin.
Inflation: an example
Look at the table first.
|Year||Gold Price-24k (1g)||Invested Amount (In Rs)||Gold Purchased (In grams)||Value of that Gold present rate (In Rs)||Money with out investment (In Rs)|
Historical gold prices: Credit: https://www.bankbazaar.com/gold-rate/gold-rate-trend-in-india.html
As you can see, the price of 24k gold was at Rs 18 per 1 gram. Today, it is around Rs 4800. That is to say; it has multiplied 267 times over 50 years. The price of gold has grown at a rate of 11.82% CAGR (Compounded Annual Growth Rate) due to inflation.
In the year 1970, if you had invested Rs 1,00,000 in gold, you might have got 5.5 kg of gold. However, today, with Rs 1,00,000, you can buy only 21 grams of gold. Thus, the purchasing power of your money decreases with time.
Look at the 5th column. It tells you the value of your gold at the current price purchased in different decades. For example, if you had invested Rs 1,00,000 in gold in the ’70s, that is around 5.5 kg of gold, the value of that gold at the current market price is about Rs 2.7 crores. The current value decreases with each increase in time. For example, if you had invested Rs 1,00,000 in gold in the ’10s, its current value is about Rs 2.6 lakhs only.
How does inflation erode your money?
The last column is the most important one. It shows how inflation eats up your money when you don’t invest it. To clarify, suppose you kept your Rs 1,00,000 (that you possessed in the year 1970) under your bed for the next 50 years, can you imagine what might have been its value at present? To your surprise, its value might have decreased to Rs 2,550 only (assuming an inflation rate of 7% for the same period). You might have lost 97% of its value, and the credit goes to inflation. Thus, inflation: the demon ate up your money like decomposers in an ecosystem that break down dead or decaying organisms.
You may ask, “I had Rs 1,00,000 in 1970, and I kept it under the bed. In the year 2020, I uncovered it, and it is still that Rs 1,00,000. Then, how it became Rs 2,550, as you mentioned?”
Indeed, those Rs 1,00,000 in physical form have not changed, but its value has. To clarify it, I will take the help of the above table no. 1 again.
Suppose, you possessed Rs 1,00,000 in 1970. You could buy 5.5 kgs of gold at that time. But, you did not purchase. Instead, you put it under your bed. Now, after 50 years, you take the amount to a jewelry shop to buy gold. Then, how much gold you can buy with that money? It’s only 21 grams. You have the same physical notes, but its value or its worth has reduced drastically during the period. (Your money may be eaten up by white ants, a few notes or coins may not be valid today, and remember in 2016, we had gone through demonetization. I have not counted these things.)
Nominal Return Vs. Real Return
The returns you get from an investment is a nominal one. You have to deduct the inflation rate during your investment period to get the real profit. Let’s understand it with an example.
Suppose you invested Rs 10,000 in a bank fixed deposit to get an annualized return of 6%. But, to your surprise, the inflation rate during your investment period was 8%. Then, what was your real return?
To calculate your real return, you have to use the following mathematical formula.
[(1+r) / (1+i) – 1] * 100
Here, we take ‘r‘ as ‘the rate of return‘, and ‘i‘ as ‘the inflation rate‘. Therefore, the value of ‘r‘ is 6%, and the value of ‘i‘ is 8%.
The result is (-1.851%).
You can click the link below to download a copy of the above calculation for your reference.
It may surprise that you got a negative return on your investment, even though your bank has given you a positive return. In other words, the inflation turned your positive returns into negative. You can say it ate up your money. Therefore, it is essential to consider inflation in your long term financial goal setting.
Financial Goal Planning
Goals can be financial or nonfinancial. It is tough to distinguish between them. Though some goals may seem nonfinancial, a small part of money may be present there. To take an example, suppose you want to improve your personality, then you need to listen to great leaders or read personal development books, and that may require money. Thus, in this section, we will discuss how to set financial goals considering inflation.
Suppose you are a young salaried person. Your first financial goal is to buy a 2BHK flat in a tier-II city worth of Rs 50,00,000. But, remember, it’s the current price. If you plan to buy it over the next ten years, then you need to consider inflation. Let’s calculate.
Inflation-adjusted financial goal planning.
Goal – To own a flat
Current price – Rs 50,00,000
No. of years to go to achieve it – 10 years
Expected Inflation rate – 6%
Inflation-adjusted future value – Rs 89,54,238 (approximately 90 lakh)
I have taken a moderate rate of inflation. It can go in both directions. We cannot predict it; we only assume that it moves at a moderate rate.
As you have observed from the above example, if you don’t take inflation into account and start to save money, you are bound to get into trouble or may not achieve your dream home. On the other hand, with the help of the inflation-adjusted future value of your flat, you can plan your investment vehicle and the monthly installment.
By investment vehicle, I mean the investment options you have like bank fixed deposits or mutual funds, etc. However, you have to choose one according to your risk appetite and investment horizon. To get a first-hand idea, I have just given you an example for your reference.
|Rate of Return||Target Amount (In Rs)||Monthly Installment Amount (In Rs)|
Monthly Installments Set Up
For your kind information, this is just an example, and the rates of return are imaginary. In other words, they may or may not be achievable. Therefore, the sole purpose of this table is to give a fair idea of different rate of return and their impact on your monthly installment.
Like the above example of buying a house, there exist other financial goals in your life. For instance, you are planning for your child’s education and marriage, a foreign tour, or your retirement. Whatever financial goals you have, you must take into account the inflation and plan accordingly.
How to beat inflation?
To sustain the value of money, is there any way out? Do you have a roadmap to beat inflation? If not, then make one as soon as possible. Further, my answer to the above question is straightforward – ‘INVEST.’ Thus, Robert T Kiyosaki says, ‘Savers are Losers.’ Investing is something different from saving. Saving money means putting some money aside whenever you get money. But, investing means putting that money to work for you. It is always hard to beat inflation by saving, but this is not true if you invest with proper knowledge, skill, and expertise.
By investing, I mean putting your money in a business, in stocks, in mutual funds, in gold, in real estate, and even in commodities. But, all these investments need a certain level of expertise to take an entry and exit. You must know that unlike savings, investing goes through different cycles. Moreover, it has ups and downs. Further, understanding these cycles, taking your emotions under control, making money is a tough task.
Similarly, it may take years to master the required skills. But don’t worry. I am here to help you along with your journey.
You cannot ignore the corrosive impact of inflation on our money. The most important thing is that it is unpredictable. Therefore, it is hard to plan everything correctly. But, in my opinion, you must be prepared for the worst. By that, I mean that you can take a maximum rate of inflation while calculating the inflation-adjusted future values for your financial goals.
India is a developing country. India’s dream to become a five trillion-dollar economy may not be realized soon, but it may achieve the target by the end of this decade. Once, the economy becomes a larger one; the inflation rate becomes more stable. Thus, it becomes less volatile. Above all, there is a match between supply and demand. Let’s hope for the best and end the lesson with a beautiful quote from Ronald Reagan, the USA’s 40th president.
“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman”Ronald Reagan
I hope you enjoyed the post. Do share this post with your loved ones. Further, I would like to hear from you in the form of comments and suggestions.