Here's how you can offset the impact of soaring prices and aspirational lifestyles on your long-term savings
EVERY week, newspapers talk about rising or falling inflation. It could be just Wholesale Price Index (WPI), Consumer Price Index (CPI) or food inflation. In economic jargon, inflation, which is usually measured in percentage terms, refers to a sustained rise in prices of goods and services. There are various aspects to this simple economic indicator which reflect the value of money as of today. For example, you could buy a movie ticket for 20 paise in the 1960s, which will cost you 200 today. That's the effect of inflation which has reduced the worth of your money by increasing the cost of the ticket.
In India, inflation data is announced by the Union ministry of commerce every Thursday. India is possibly one of the few economies that still follow WPI instead of CPI, which has less relevance today. You should look at the components such as at primary articles and fuel items, which have a direct impact on your disposable income.
How Does Inflation Impact You?
Inflation is measured against a basket of commodities. Recently, the WPI fell below 8% but the prices of vegetables are still touching new highs. The vegetable vendors blame it on unseasonal rains. So, how do you describe this anomaly? Food products are only one component in that basket. If the prices of other components fall and those food items keep rising, the index will still show an overall decline.
Secondly, inflation has taken the food product prices to a higher plateau. Inflation measures the increase in prices over time. If tomatoes cost 30 last year and this year they cost 32, the inflation will be around 6.66%. It may sound reasonable. But it is on a high base of 30 per kg.
But why do you feel the pinch? It is because you cannot cut down on basic consumption needs. Moreover, if your salary has not increased in line with inflation, you will have to spend much more to buy the same quantity of goods today. For example, if you spent 15 for a litre of milk last year, the same packet will cost you 20 this year. So you end up spending 5 more to buy the same quantity and quality of milk today. If your salary in this period has gone up by 33.33%, you are spending the same amount of money on buying milk for a single day. If the rise in the salary is lesser than 33.33%, you are spending more, taking a hit on your finances. The demand for basic necessities like food is inelastic to price rise. Hence, even if food prices go up, they will eat into your savings as you can't cut down beyond a point on such needs.
Lifestyle Inflation:
There are two versions of lifestyle inflation. As your income increases, you tend to acquire some expensive tastes and desires. The other form of lifestyle inflation is very specific in nature. For example, if your hobby is to travel and explore the world, then it is an expensive pursuit, considering soaring oil prices. Earlier, the concept of lifestyle inflation was not prevalent. This was because the growth in income of most individuals was usually 5% over and above inflation. Consequently, there was no surplus income in the individual's hands. Things have changed now. The income grows a minimum of 10% in excess of the inflation. So, affordability is much higher, which makes people succumb to aspirational and peer pressures.
But it has other implications. On the one hand, a higher disposable income allows you to pamper yourself with a lavish lifestyle. On the other hand, you realise that your retirement benefits have reduced. This means that you have to save higher to be able to maintain that lifestyle, post retirement.
It's crucial to provide a certain mark-up at the planning phase itself. For retirement planning, every individual has to do a certain loading on numbers today based on their lifestyle to get the required future value. Again, this loading has to vary from period to period so as to reflect true value. For example, let's assume you are 30, with a monthly expenditure of 25,000 and you want to maintain the same lifestyle after 20 years. Considering inflation of 7%, you will need 96,742 in the first month after 20 years. Which means the future value of present 25,000 will be equal to 96,742 after 20 years, considering an annual inflation of 7%. If Mr X wants to retire at that point of time and the inflation is assumed at 7% thereafter, he should have at least 3 crore. The other assumptions are life expectancy of 80 years and returns of 8% from his corpus of 3 crore.
Inflation & Investments:
On the savings side, inflation eats into the value of idle cash lying in your bank account. The annual return of 3.5% can actually have a negative value, thanks to double-digit inflation. You must also compute the real rate of return on investments to assess inflation's impact. Fixed deposits, PPF or National Savings Certificate assure safe returns but are not capable of beating inflation. Gold has been an effective hedge against inflation and so are equity and real estate over a period of 10 years, financial advisors say.
Inflation simply erodes the value of your investment. Let us assume you invested 1,000 in a one-year fixed deposit at 7%. The value of the deposit would be 1,070. But if inflation touched 8% that year, the value of 1,000 decreases by 80. The net value of your money will be 990 only. So, the net gain after computing the loss of value due to inflation is actually negative. Whenever you invest in an instrument, compute the future value after accounting for an inflation of 8-10% to get accurate results.
Retail investor should invest in investment vehicles like equity mutual funds or PMS products. Even risk-averse investors should include some equity investment in their portfolio. Products like MIP (monthly income plans, NPS (National Pension Scheme) or structured products can be a good choice for investors who have low risk-appetite. Property investments and rentals from them can also, to some extent, help in mitigating the problem of inflation. Data shows that asset classes such as real estate and equities have outperformed inflation.
Working:
Mr X AGE: 30 yrs Inflation Rate: 7% p.a.
Monthly expenditure in... 2010: 25,000 2030: 96,742 Total corpus needed after
20 yrs: 3 crore
Future Value= (Inflation Rate/100) n × Present Value Of Your Corpus Note: n stands for the number of years
