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Inflation or price inflation is the general rise in the prices of various commodities, products, and services that we consume. Inflation erodes the purchasing power of money. The following table explains what inflation can do to the purchasing power of our money.
The numbers are arrived at by using the future value equation, i.e., A = P * (1 + r) ^ n, where A is the future value (the values in the right-side column); P is the present value (Rs. 10,000 in the example); r is the rate of inflation (8% p.a. in the example); n is the number of years (the periods in the first column in this table).
The above table shows how fast the purchasing power of the money goes down. This risk hits hard over long periods. If this is not properly accounted for in the investment plan, one may fall short of the target when the need arises.
One may also look at the impact of inflation in another way. If one could buy 100 units of something with Rs. 10,000 today, assuming inflation of 8 percent p.a., one would be able to buy only 68 units of the same thing after 5 years, and only 46 units after 10 years. This clearly shows the loss of purchasing power.
In this context, it is pertinent to take a look at whether the investments are able to protect purchasing power or not. In order to protect the purchasing power, the investment return should be at least as much as inflation. If the same is higher than inflation, the purchasing power increases, whereas if one earns lower returns than inflation, the purchasing power drops.
Incidentally, when one seeks the total safety of invested capital, along with anytime liquidity, the investment returns are usually lower than inflation. Take for example, if you earn an interest rate of 7 per cent p.a. on your fixed deposit when the inflation is at 8 per cent p.a., it is obvious that the investment grows at a slower pace than the rise in prices. The returns on investment without factoring inflation is known as the “nominal rate”. However, when this number is adjusted for inflation, one gets the “real rate of return”. If the investment returns are higher than inflation, the investor is earning a positive real rate, and vice versa.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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