Inflation vs Investment
In the below post we have tried to give you an idea of What is Inflation & How to beat Inflation by Investing?
Inflation is the general and consistent increase in the price levels of goods and services in an economy over a period of time. It refers to the rise in the average price levels of both good and services that are commonly used such as clothing, food, transport, housing, recreation, consumer staples etc. It is calculated in terms of change in percentage. If the inflation rate is 5%, this means that the price levels of goods and services have increased by 5% over the previous period. This increase in prices is relative to the money currently available. In essence, buying the same amount of good or services will cost you 5% more than they did previously. Therefore this increase in prices leads to a decline in the real value of money and a loss of purchasing power for buyers.
This brings us to the importance of saving money and investing in order to beat inflation. In order to preserve the purchasing power of your money, your investments should beat inflation, you have to be earning higher returns from your investments and this in turn should be higher than the inflation rate of the economy. Let’s say you have invested Rs 100 in an investment which returned 8% in the next year. The value of this investment becomes 108. Also, assume that the inflation rate in the economy is 10%. It can be clearly seen that your return on investment is lesser than the inflation rate and this nullifies the returns that you have earned.
This brings us to the concept of Real Rate of Return (RRR). It is the net return after adjusting for inflation. It is calculated as follows:
Formula to calculate Real Rate of Returns (RRR)
Real Rate of Returns = [(1+ nominal rate of return) / (1 + inflation rate)] – 1
Ideally an investor should workout his personal inflation. Because inflation may vary from family to family depending on size, composition and lifestyle of the family. For eg: A family with school/college going students may have a higher inflation given that education has one of the highest inflation rates among various sectors. A family without kids may have lower inflation If it is difficult to ascertain inflation an investor can always look at the CPI (Consumer Price Index) inflation numbers published by the government.
- India’s March retail inflation as measured by the CPI stood at 5.52%
- SBI’s 3 year Fixed Deposit rate is 5.1% (pre tax)
- The real rate of return for the investor for the above FD would be roughly negative 0.40%
- If we consider a tax of 20% than the real rate of return will be negative 1.35%
So clearly keeping money in fixed deposit provides negative real rate of return. Investors should keep inflation and real returns in mind while making any investment.
A good strategy to beat inflation is to invest in products or things that have a high probability of being equal to or more than the rate of inflation in the future. In order to do this, investors will have to research well on their own risk profiles and goals.
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