Inflation: The Quiet Culprit Behind Your Shrinking Buying Power
High inflation is like a termite that eats into the returns generated by the savings and investments of an investor
When investing, we think of returns. However, what we may fail to realise that the return we get on our investments is not the real return. First, taxes need to be paid. And then there is inflation.
“Inflation is a hidden tax that reduces the value of your savings over time. In simple terms, its effect is that in the future, one would be able to buy a lower quantity of goods or services than they can now,” says Abhishek Kumar, Founder, SahajMoney, a financial planning firm.
Hence, it is important that inflation is always a part of your financial planning and wealth creation process.
High inflation is like a termite that eats into the returns generated by the savings and investments of an investor. Let us assume the net return on investors portfolio is eight per cent and inflation rate is 5 per cent, the net real rate of return for him is only three per cent. If the return rate is low and inflation rate is higher then the portfolio generates negative returns.
“For a risk averse investor, the situation becomes adverse with high inflation. For instance, assume an investor who keeps all his money in savings and fixed deposits. His post tax returns would be around 4.5 per cent. If inflation is 5 per cent then real returns are -0.5 per cent,” says Gaurav Goel Securities and Exchange Board of India (SEBI) registered investment advisor.
Adverse Effects Of Inflation
Let us understand the adverse effects of inflation.
Reduced buying power
As prices rise, each unit of currency buys fewer goods and services. This means that even if your savings grow nominally, you might be able to purchase less with that amount than you could today.
Negative Real Interest Rates
“When inflation exceeds the nominal interest rate on savings, real interest rates become negative. This situation means that savers are essentially losing money in real terms, even though the nominal balance might appear to grow,” says Goel.
Impact on Retirement Savings
Long-term savers, particularly those saving for retirement, need to consider inflation in their planning. “If inflation is not accounted for, retirees might find that their savings don’t last as long as expected, or they might not maintain their desired standard of living,” says Goel.
How To Fight Inflation
If you do not have a few hundred crore rupees in your bank account, the only way to beat inflation is to invest in assets that can give returns that beat inflation or at least match it. “One can protect themselves against inflation by investing in a diversified asset class that has the potential to beat or at least keep up with inflation. A portfolio of investments across equity, gold, and inflation-indexed bonds presents an opportunity to beat inflation over time,” says Kumar.
Here, one needs to remember the power of equity. For example, if we consider BSE Sensex index funds, they have given return of over 15 per cent in the last 5 years. Index funds are funds which tracks an index, and you do not even need to pay high fund management charges. Compared to this, if you had put your money in FDs, you would have got a return of about 7 per cent. Inflation is a hidden enemy, but investing in equity can help you beat it.
