We have heard of Blood Pressure or BP as a silent assassin as it slowly but surely weakens key organs and nerves. It can cause stroke and heart attacks, which can kill or debilitate. All this with little or no symptoms that you have BP. If you have already been impacted, then few medicines and a healthy lifestyle can help you keep it under control. The best thing for this disease is awareness and early detection.
Have you ever wondered if this has parallels in the financial world? Is there a silent assassin of financial health? Is there anything that weakens wealth and can result in loss of financial freedom without you knowing it?
Yes there is. It's called Inflation. It impacts all aspects of your financial life and therefore life itself. What you earn, save and invest, are all impacted by it. If ignored, it can have a very detrimental impact on your future.
Are we more susceptible to it? Yes, low awareness, traditional saving habits and lack of financial advice make us more susceptible to it. Let's first understand how inflation impacts us. To understand that, let’s know first what is inflation? For general public, it is usually a general increase in prices of goods or services. The lesser known aspect or meaning is that it means fall in purchasing power of money.
Let's look at these two aspects and its impact on financial health.
Increase in prices of goods and services: This is the most common aspect of inflation that we are aware of. We know that the prices of goods & services increase annually. How many times have we heard our parents and grandparents fondly talk of prices during their ‘times’. Like a bus ticket for Rs. 1 which now costs Rs. 20.
How does this impact your planning? To illustrate, if you are planning for your retirement after 20 years - The cost of a Rs. 20 bus ticket at an assumed nominal 6% inflation after 20 years will be Rs. 64. Essentially, if you are planning to retire after 20 years, then at 6% inflation you will have to plan for 3x of everything. So if your monthly living expense is Rs. 50,000, you will require about Rs. 1.5 lakhs on retirement for those same monthly living expenses. And this amount will increase further for your entire post retirement period given that inflation will probably outlast all of us.
Fall in purchasing power of money: Have you heard your grandparents / parents telling you about currencies like ekanna, naya paisa etc. They would tell you how much they could get for these amounts. In recent memory we have seen, 5, 10, 25 & 50 paisa coins go out of circulation. We have seen them lose their value or purchasing power. There was nothing that could be bought by these currency denominations and they went out of circulation. This is the impact of inflation.
Now that we know the 2 aspects of inflation, let’s see the habits that cause it to turn into a financial disease or a silent killer
Saving in Cash: India is a cash economy and we have reached our pre-demonetization levels in terms of cash with people and circulation. While money is good for circulation, cash hoarding is bad from an investment perspective. If say you hold a 100 rupee note for 3 years, then because of inflation of say 6% its purchasing power will be reduced to Rs. 94 at end of first year. That means after one year, Rs. 100 will be able to buy goods worth Rs. 94 only at current year prices. Similarly, at the end of third year, it will be able to buy goods worth Rs. 83 only. After 20 years, it will be able to buy goods worth Rs. 29 only!
Traditional savings instruments: We often let our money lie in traditional savings accounts. If you look closely at the interest earned, they may not be more than the inflation rate. Thus you could be losing money or making a marginal real return. Now what's real return - it's the return minus the inflation. To illustrate, if interest rate is 4% annually and the inflation is 6% annually then, the actual return is -2%. That means its losing its purchasing power by -2% that year. If it is 6% interest then your money is barely maintaining its purchasing power.
Lack of financial advice: We usually do not have a financial planner who can help us with healthy financial habits and goal based planning. Financial planners are like doctors who can help measure your financial fitness and recommend you right financial lifestyle.
Now that we are aware of the silent killer and the doctor viz. Financial Planner, it’s time to take precaution and look at inflation-efficient methods of investing. If you have a long term view then, your planner may recommend equity based instruments which may provide you better real returns. He may also help you with taxation and goal based investing.
Inflation is good too for economy in general. It helps producers get better price for their produce year on year. Moderate inflation is good for economy just like normal blood pressure. It's how we manage our investments that will help us stay ahead of inflation with better real returns.
The inflation & interest rates provided in the article are assumed rates and are for illustration purpose only.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.