Financial planning is like a guiding map. But one needs to understand that it is just a tool and the output is just a function of what input we feed in.
One of the most important and tricky variables to feed, in any financial plan is “Rate of Inflation”.
Inflation denotes a rise in the general level of prices. Inflation reduces the purchasing power of each unit of currency.
For Each, His Own
Although, inflation number is published on a monthly basis by MOSPI and it tells us about increase in a general price level, it is not at all comprehensive indicator of how your expenses have moved. Inflation for various individuals having various socioeconomic backgrounds, life stages and behavior pattern is different.
To give an example price of iPhone 4 launched in May 2011 was Rs. 40,900 and iPhone X launched in November 2017 costed Rs.80, 600, which means prices of iPhone have grown at 13% CAGR. In the same period CPI has grown by 6.7%. As our standard of living improves our inflation also increases. If you plot your expenses over last 5 years you will realize how our consumption pattern has changed. Our day-to-day expenses either get expensive or as our standard of living improves, we move to more branded and expensive things.
Understanding Real Return
The real return is simply the return an investor receives after the rate of inflation is taken into account. For example, if my investment is yielding me 7% return and inflation during the same period was 5% then my real return is 7% – 5% = 2%.
As an investors we need to be cognizant of the fact that whether we are getting returns which are more than the Inflation rate. If not, our ability to purchase same good in future is getting hampered.
So, while planning for the future we need to keep this silent thief away from eating into our pie