The Impact of Inflation on Your Financial Goals

Investing for Long-Term Growth: Time vs. Inflation

Inflation in India typically ranges between 4-7%, and its impact on your finances can be significant over time. For example, at a 6% inflation rate, something that costs Rs.10,000 today could cost approximately Rs.20,000 in 12 years and around Rs.35,000 in 20 years. And this is just the general inflation rate! In certain sectors, such as education, inflation rates are much higher—reaching up to 11%.
This means the purchasing power of your money today will decrease over time, requiring more money in the future to buy the same goods and services. Factoring inflation into your financial planning is essential to ensure your money grows in line with rising costs.

Let’s consider an important financial goal—saving for your child’s undergraduate degree in 10 years.

Today, the average cost of an undergraduate at a private university is Rs.10,00,000. To prepare for this, you decide to invest Rs.10,000 monthly in a savings account with an assumed average return of 4% annually. After 10 years, your investment will grow to approximately Rs.15,00,000.
At first glance, this seems like a great outcome, as it’s more than the current cost of the degree. However, this is where inflation becomes a game changer. Education inflation in India averages around 11%, which means that in 10 years, the cost of the degree will rise to about Rs.28,00,000.

The graph above illustrates two key scenarios:
1.    How a monthly investment of Rs. 10,000 in a savings account grows at 4% annually over 10 years.
2.    The impact of 11% education inflation on a current cost of Rs. 10,00,000, demonstrating how the future expense increases substantially.

The arrow highlights the importance of factoring inflation into your financial plans. While saving consistently is great, ensuring your returns outpace inflation is key to achieving your goals.

How Inflation Impacts Long-Term Financial Goals

Inflation doesn’t just impact our day-to-day expenses but also significantly affects long-term financial goals. In fact, the longer the time horizon of a goal, the more the impact of inflation is likely to be.

Let’s explore how inflation influences different long-term goals:

Retirement

When planning for retirement, it’s important to ensure that your post-retirement lifestyle matches your current standard, covering day-to-day expenses like groceries and transportation. Many people even aim to upgrade their lifestyle, with more time for activities like travel. For example, if your current income is Rs. 2 lakh per month and you retire in 20 years, maintaining the same lifestyle could cost you around Rs. 6.5 lakh per month, assuming a 6% inflation rate. This makes it essential to incorporate inflation into your financial planning to live a comfortable post-retirement life.

Home Purchase

Purchasing a home is often a long-term goal and can be significantly impacted by inflation. Over the past 5 years, real estate prices in metropolitan cities like Gurgaon and Mumbai have risen by about 20%. A house that cost Rs. 1 crore five years ago might now cost close to Rs. 2.5 crore.

Inflation doesn’t just affect property prices; it also influences home loan interest rates. When inflation rises above the target range, central banks increase interest rates to curb spending and borrowing, making loans more expensive. This impact makes it crucial to plan your home purchase with a smart investing process.

Child’s Education

Education is significantly impacted by inflation, typically rising at a rate of 11-12%. This means that education costs can double in just 7 years. For instance, the fee for a BTech degree at IIT has jumped from Rs. 50,000 to Rs. 3,00,000 in just 6 years. Beyond tuition, additional costs also add up significantly.

Child’s Marriage

India is renowned as the largest wedding destination globally, with celebrations often spanning several days. Your child’s wedding is a very special occasion, but it’s essential to plan not only for the various ceremonies but also for the impact of inflation. In 2023 alone, wedding expenses increased by 25-30%, including key aspects like venues, catering, and more. Early and thoughtful financial planning can ensure this special day is as memorable as you envision.

Build an Inflation-Proof Investment Strategy

Inflation lowers your real returns if your investment earnings don’t keep up with inflation. Let’s read how you can tame the devil that is inflation:

1. Invest Wisely: Make sure you follow an investing process with your goals being primary. A good investing process will ensure that it takes inflation into account when deciding the target amount.

2. Take Informed Risk: While many investors prefer low-risk options, it’s important to understand that not beating inflation is a risk. This can hinder you from achieving meaningful financial goals, such as retirement or property purchases. 

3. Diversify Your Investments: Make sure your investments are spread out smartly between equity, debt, and hybrid funds, keeping your goals in mind. That way you have the potential for high returns and stability during high inflation. 

4. Be aggressive for Long-Term Goals: The value of your money can decrease a lot by the time your long-term goals such as retirement approach. In such cases, opting for an aggressive approach can be beneficial. 

5.  Invest for the Long Term: Equity investments have historically beaten inflation in the longer term. But your priority should be a subset of good investing practices that focus on diversification, risk management, and aligning with your long-term financial objectives.

FAQs

What is Inflation?

Inflation is the rate at which prices of goods and services rise over time. This means that what you can buy today for a certain price will cost more in the future due to inflation.

What is the average inflation rate in India?

Inflation in India typically ranges between 4-7%, but certain sectors like education and healthcare experience much higher inflation rates, sometimes exceeding 10-12%.

Are Fixed Deposits (FDs) a good option to beat inflation?

Fixed deposits usually offer returns of 6-7%, which may barely keep up with inflation or fall short in the long run. While they provide stability, they are not the best choice for wealth creation or achieving long-term financial goals.

Should I take a conservative or aggressive approach to counter inflation?

Your investment approach depends on factors like goal tenure, risk capacity, and inflation. While long-term goals impacted by inflation may require a more aggressive strategy, the approach is completely based on a personalized investing process.