Why Should I Bother About Inflation While Planning investments - MySIPonline
Nov 06, 2017 4 min read

Why Should I Bother About Inflation While Planning investments?

What is inflation and why does it impact investments?
There are certain factors which should be crucially taken into consideration while making financial plans. People keep knocking at the doors of the experts to know about such elements so that they can head with proper arrangements. Are you aware of such factors? No!

We are here to help you develop a better understanding of investments so that you can efficiently make your decisions while making investment plans. Many investors have asked this question that what is inflation and why should they bother about it while planning investments. Therefore, we have brought you an easy approach to help you understand the concepts of inflation and its impact on your investments because it is one of the most crucial factors which must be considered while financial planning.

What Is Inflation?

In simple terms, the rate of a gradual increase in the prices of the goods and services is called inflation. It highly impacts in the overall condition of the economy of a country. When the prices of the consumables get gradual hikes, it reduces the purchasing power of the citizen leading to the lower purchasing power of the country which ultimately results in the falling value of the currency. For example, you could have purchased a lot many things by spending only Rs. 100 back ten years, but today, the value of Rs. 100 is merely considered. This fall in the value of currency occurred due to the rise in the prices of goods and services in the country over time. This gradual increase is termed as inflation.

What Causes Inflation?

Generally, the economists classify the inflation into two types, namely demand-pull inflation, and cost-push inflation. Both the types have the impact on the overall price level of the economy. Let’s know a brief about both the categories:

  1. Demand-Pull Inflation: In this situation, the demand for the goods/services in a country increases more than its supply. It leads to an increase in the prices of the goods/services which causes inflation when repeated gradually. For example, in India, there is an insufficiency of medical facilities in comparison to its demand. That is why, the inflation in the medical sector is higher than that of any other sectors.
  2. Cost-Push Inflation: It happens when the cost of the production increases due to rise in the prices of raw materials, wages, etc. The rapid increase in the prices of the cost of the production cause inflation.

Impact of Inflation on Investments:

You must consider inflation rate while planning your financial targets; else you may fall short of money to fulfil your dreams. By doing so, you can effortlessly achieve all your future goals. Let’s know how it impacts on investments:

Suppose the rate of one kilogram of rice is Rs. 100 and you are purchasing five kgs every month. This way, you need to spend Rs. 500 per month. Now, considering the inflation rate at 10% p.a. The price of the commodity will increase 10% per annum consistently, and your purchasing power will be reduced resulting in making you financially weaker. In the table below, the case is shown that how your buying power gradually decreases when the prices of the commodities go consistently upward:

Therefore, from the data given in the above table, you can understand how the increasing rate of the products and services impact your purchasing power. Now, let’s take another case, to understand more deeply that why should you consider the inflation in your financial plans?

Two friends A & B put aside Rs. 50000 each for meeting future financial requirements. A invested it in savings bank account which provides him interests at 4% p.a., whereas B, being a little smarter, invested in mutual funds so that he could beat the inflation rate and fulfil his dreams efficiently. After five years, let’s see the valuation of both the investments considering the inflation at an expected rate of 6% p.a.

Total Value of A’s Investment:

Rs. 50000 @ 4% p.a. for five years = Rs. 60830 After five years the inflation will make the prices of the commodities dearer each year. If the expected rate is 6% p.a., then the price of the commodity will become Rs. 66911.20 after five years. It shows that the profits earned by A from his savings account are not actually profit but negative returns if we consider the inflation. Although he has earned Rs. 10,830 on his investment, but the prices of the commodities rose faster than his savings.

Total Value of B’s Investments:

Rs. 50000 at expected returns of 15% for five years = Rs. 1,00,568 More than double. B’s investments grew more than double its value and beaten the inflation too. Now, B can effectively use this money to fulfil his financial dreams.

So, how do you want to make your financial plan? We suggest investing in mutual funds so that you will also be able to reap exponential returns beating the inflation, and fulfil all your financial dreams efficiently. We, at MySIPonline, offer you effective methods of investing in the mutual funds of the top AMCs of India. You can choose as per your suitability and can also consult with our experts.

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