Long-term goals such as child education, marriage, home buying or one’s own retirement are impacted by rising inflation. With price rise, the purchasing power of the Rupee falls. Therefore, inflation may spoil your financial planning unless you account for it right at the beginning.
As an investor, inflation plays a spoilsport as it eats into the returns. The higher the inflation, the more the damage to your returns. For example, if you expect your portfolio to generate a return of 8 per cent after taxes over the long term, and the annual inflation also remains around 8 per cent, your real return will be almost zero!
Therefore, when you plan your investments towards your goals, make sure you account for inflation. For example, if you are saving for child education after 21 years that costs Rs 25 lakh today, the inflated amount could cost Rs 70 lakh after 21 years, assuming a 5 per cent inflation rate.
Thereafter, one has to invest to accumulate Rs 70 lakh and not Rs 25 lakh.
Similarly, if you are planning to save for retirement, first consider your monthly expenses at current costs.
Assuming a 5 per cent inflation rate, find out how your monthly expense will be after retirement. This gives you the amount of inflated monthly expenses you would need to survive during your retired years.
Thereafter, calculate how much you need to start saving from now till your retirement age to create a corpus that could provide you the inflated monthly amount.
Without knowing the exact monthly savings required, one should not venture into planning and savings for one’s retirement.
While investing for a goal, many investors consider the goal’s value at current cost. So if a child’s education costs Rs 12 lakh today, the parent ignores its inflated cost after 15 years and starts saving a certain amount, say Rs 2500 a month, towards it.
After factoring in inflation, of say 7 per cent per annum (education inflation is considered even higher), Rs 12 lakh balloons to about Rs 33 lakh after 15 years.
Instead of Rs 2500, if the investor would have invested Rs 5600 a month, the target inflated amount (of Rs 28 lakh) would have been achieved.
Inflation is the enemy of your goals, and slowly and steadily it takes you farther away from them. To tackle it, account for it now so that its impact is minimised. The day you start investing, factor in inflation and invest accordingly.