Skip to main content

Inflation & Its effect on your Financial Goals



Each goal has two components — a time-frame over which it has to be achieved, and an amount of money that will be needed. From this point onwards, it seems like a simple matter to calculate what needs to be done. If you can assume a rate of return, and know some basic arithmetic, you can figure out how much needs to be invested and how much the returns must be for the target to be reached.


However, there are some ifs and buts. Unless these are taken into account, the end-result may not be as happy as the calculations indicate. One of the common hurdles is inflation. This is surprising since inflation is so much in the news but most of us fail to appreciate the huge impact it can have over the very long-term. The problem is that assuming a likely rate of return and a likely rate of inflation introduces two independent compounding variables in the calculations. If your estimates are off the mark, your calculations could go haywire.


And given that human beings (specially human beings who invest!) are inherently optimistic creatures, they are very likely to underestimate inflation and overestimate returns. But there's a neat way around this problem. The trick is to appreciate that inflation and investment returns are not independent variables. Generally speaking, most asset types can reasonably be expected to generate returns that are inflation + n%, and the range over which 'n' is likely to vary is much smaller than that of the total returns.


Even for something as stable as bank fixed deposits, you'd be hard pressed to estimate returns over the next 10 years. However, you can pretty much be sure that the returns will be about the same as the inflation rate, perhaps a per cent lower.


This makes it much easier to make an inflation-adjusted long term target estimate. Basically, you can just estimate that your returns from an FD will be zero and you will just get your money back. This works for equity too. It's not as precise, obviously, but you can assume that your real equity returns will be about 5% and you will be a lot less wrong in planning your target estimating inflation and returns separately.


So much for inflation. However, do appreciate the fact that this is not a trick of calculation. All returns are, in a manner of speaking, indexed to inflation in some way or another, even in equity investing. Some companies grow faster and some grow slower, but inflation is built into all the numbers that make up that growth. It is genuinely a more accurate method to predict returns as something +/- inflation rather than make independent predictions for both returns and inflation.

There are a number of other things that you need to take care of if you'd like to invest towards a target. Your approach would be different depending on whether the time frame is negotiable, and whether the amount is negotiable. You would also need to change the asset type in which you are investing depending on the time frame. I'll write about these in future.
 

Popular posts from this blog

NRIs and direct taxes code (DTC)

DTC Proposes To Do Away With Special Provision That Allows NRIs Liberalised Duration Of Stay In Country      THE new direct taxes code could bring a large number of global Indians under the tax net, as it does away with a provision that allowed individuals to escape tax in any country citing double tax avoidance.    The new legislation, introduced in Parliament on Monday, says an individual shall be a resident of India in any financial year if he is in the country for more than 59 days in that year, and has been has been India for more 365 days in four preceding financial years. A number of Indian industrialists including Vedanta's Anil Agarwal and Essar's Ravi Ruia have acquired non-resident status over the years.    The DTC has only attempted to clean up the provision in line with the laws globally. A phrase "being outside India" in the existing income tax law exempted individuals who stay outside the country for six months from paying taxes. This was prone ...

Stick to Good Fund Manager who Can Multiply Your Investment

A manager may be the difference between the best and worst funds. Here's how you can find the right one    Does a mutual fund manager make a difference to your investment? The answer may not be as easy as you think, since most best-performing mutual funds have moved away from individualistic fund management to process-driven methods, limiting the scope of an individual's role in investment decisions. In fact, many fund managers would speak at length about how the "system" their fund house has in place makes their task of picking stocks easy even though it restricts their freedom. Still, the question is important, especially after recent reports that the Securities and Exchange Board of India ( Sebi ) may ask fund managers to disclose to investors their track record of managing money. Let us take a look at the universe of large-cap funds over the past five years. According to Value Research, an independent mutual fund tracking firm, the topper in the category is DSP...

Tata Fixed Income Portfolio Fund dividend

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)       Tata Mutual Fund has announced dividend under the dividend option of Tata Fixed Income Portfolio Scheme B2 Plan A-DQ, Tata Fixed Income Portfolio Scheme B2 Reg-DQ and Tata Fixed Income Portfolio Scheme B2 Direct-DQ. The record date has been fixed as August 29, 2013. Happy Investing!! We can help. Call 0 94 8300 8300 (India) Leave your comment with mail ID and we will answer them OR You can write back to us at PrajnaCapital [at] Gmail [dot] Com --------------------------------------------- Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax under Section 80C. Invest Tax Saving Mutual Funds Onlin...

IDFC Classic Equity Fund

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)   IDFC Classic Equity Fund IDFC Classic Equity is a large-cap equity fund which currently has assets under management worth Rs. 158.52 crore. It was launched in August 2005. The fund is benchmarked against the BSE-200 Index. Performance YTD 1-Year 3-Year 5-Year Since Inception IDFC Classic Equity 0.93 26.61 6.30 1.01 11.65 BSE 200 1.52 17.31 6.00 1.99 12.98 All figures in % as on January 31, 2013; Returns above one-year in CAGR terms ...

Mutual Fund Review: HDFC Mid-Cap Opportunities Fund

LAUNCHED in June 2007, HDFC Mid-Cap Opportunities Fund was started as a three year closed-ended scheme. It was subsequently converted into an open-ended scheme in June 2010. The fund has been ranked as Crisil Fund Rank 1 in the small & midcap equity category according to Crisil Mutual Fund Ranking methodology over two of the last four quarters and has been present in the top 30 percentile in the category for all the four quarters. Crisil Mutual Fund Rank 1 funds form the top 10 percentile of the ranked universe representing very good performance vis-à-vis category peers. The fund, managed by Chirag Setalvad, has assets under management of ` 1,275 crore as of April 30, 2011 and has outperformed its peers and the benchmark (CNX Midcap Index) in the 1, 2 and 3 year time frames. INVESTMENT APPROACH The fund's objective is to earn capital appreciation by investing in equities of small and mid cap companies. While these companies have a higher return potential than large cap ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now