“ Hamare Zamaane mein, Dus rupay mein kitna kuch mil jaata tha… (English Translation) In our childhood, we used to get so much for Rs. 10… “
How many times have we heard this from our parents or grandparents and we would laugh at their nostalgic talks.
However, you will hear yourself say the same thing to your children or grandchildren one day. That’s how it works, it’s a never-ending process, prices increase over a period of time. The rate at which it increases is called the inflation rate. As long as there is demand, inflation will continue, though the rate could keep differing.
If you want to understand inflation, ask your elders what the cost of a particular item was in their times and see what it is now. This will give you an idea about what it may cost later.
Inflation is nothing but increase in the cost of living over a period of time. This increase in cost could be due to various reasons, most common being rise in input costs like fuel, labour leading to higher production costs or government fiscal policies, etc.
The real question is, why am I talking about it? How does it impact you an investor?
The reason you need to know about inflation is that it sneakily eats into your gains or returns that you earn from your investment. You won’t even realise it, but as the cost of living keeps increasing, you keep spending more, your savings reduce and your purchasing power reduces. The impact of inflation may seem small in the short term, but over the course of years and decades, inflation can drastically erode the purchasing power of your savings.
As the above illustration shows, as the years go by, the cost of the same things keeps increasing, so if your investments don’t match this, you will find the gap between your savings and cost of living widening over the years. So, what’s the solution to this? How do you invest in such a way that you reduce this gap? In the short term, it may not be possible, however, if you have a goal that is 10 years away and current cost of is Rs. X then consider the future value of it and invest accordingly. At present everyone is investing looking at the current costs, so in the long run you will find the gap widening and the goal going further away and, in some cases, unattainable.
In order to ensure that you achieve your goal and avoid disappointment, invest regularly, consider doing SIPS(Systematic Investment Plan) in equity mutual funds and take the benefit of its compounding effect. Depending on your age and risk-taking capability, at least 50% of your portfolio has to be in financial instruments that beat inflation like Equity, Gold, real estate and provident fund. All these products have given returns above the inflation rate. Highest being equity, so be sure to have a healthy allocation in all these asset classes based on your risk-taking capability. Please remember you need to invest regularly and stay invested in it for a long time.
As they say, the biggest risk is not taking any risk at all. Ignoring inflation is not an option, it’s a necessary part of your financial planning.