Scott Droney - How Does Inflation Affect Your Financial Goals

1. Scott Droney - How Does Inflation Affect Your Financial Goals Have you ever thought that inflation could dent your beautiful dreams of the future without you even realizing it? Let's explain how. But before that let's talk a little bit about inflation for the benefit of the novice. Inflation is the rate at which prices of goods and services increase from year-to-year in a country or economy. This means the purchasing power of the currency of the economy falls due to inflation every year as time passes by. For instance, if a pack of biscuits cost INR 20 last year and inflation is currently 5%, the same biscuit pack will now cost INR 21. This means, you need INR 21 to buy the same pack of biscuit this year or the purchasing power of the Rupee has gone down by 5%. From the above example it is evident that inflation will increase the price of everything that we consume on an annual basis. This simply implies, cost of living increases every year as products and services cost more than what they costed the year before. Thus we need more money to spend on the same thing in the future than what we are spending on it now. That is the reason why you ask for a good salary hike every year so that you can still have some additional money after removing inflationary effect from your increment. For instance, if your boss gave you a 12% hike, don't get too excited because the real effective hike or increment that will come into your hands in only 7% after removing inflation.

2. But you may be thinking, this is common knowledge. What's the big deal about it? Everyone faces inflation. So why should I worry too much about it. The reason you should worry about is that inflation is going to slowly eat away your savings. What you are currently saving for a financial goal may not be sufficient at all when you consider the compounding effect of inflation on it. For instance, you may be saving for your retirement or child's college education or her wedding. You may have assumed a certain cost that you'll incur in future for funding these goals. But have you factored the impact of inflation into the future value of these goals? Let's take the help of an inflation calculator to do some reality check in life. The inflation calculator helps you find the amount you'll need in future to meet your current expenses. It tells you how much you will need to pay for an expense that is costing say Rs. X today. Let's take an example to illustrate how to use this calculator. Suppose you are 30yrs old and your monthly household expense is INR 30,000. You are planning to save enough for your retirement phase of life that is supposed to begin 30 yrs from now. How will you find out how much money you will need every month to maintain a similar lifestyle 30 years later? Feed in the following input into the inflation calculator: Value of Current Expense = 30,000, Rate of inflation = 5% and Time Period = 30yrs. What do you get as the future value of your monthly expense that grows just at the rate of inflation and this calculation assumes you will maintain the exact same life style that you have at the age of 30. The answer is 1.3 lakhs per month. This is the money you'll need every month to live the same life at the age of 60. If you want to improve your lifestyle which is bound to happen by the time you are ready to retire, the amount required would be more than 1.3 lakhs. Historic data shows inflation rate has averaged 7.7% in India for the period 1969 to 2013. Now do you see how inflation can play havoc on your dreams by slowing eating away a part of your savings right under your nose. Hence it is important to invest wisely from an early age so that your investment grows at a rate higher than inflation and you can afford to have a better lifestyle at retirement than you currently have. Obviously, you need a more comfortable life as a senior citizen than as a youngster. You can afford to take a bus or metro at this age but at 60, you would prefer to take a cab or have someone drive you. Won't you?