There was a week last monsoon when a bunch of coriander leaves bought from the local vendor with a cart, cost me ₹150!!! Unfortunately, my food aesthetics make me feel that Indian cooking served without coriander garnish looks insipid. Hence, I bought the bunch with a great deal of incredulity. The price for that bunch has dropped significantly since, but I’m still paying ₹30-40 for it.
Slightly more than two decades ago I remember helping out my mother with some vegetable shopping a few times a week and each time the vendor would drop a fistful of green chillies and bunch of coriander into our bag, given at no cost. It was the norm everywhere. Maybe in the next two decades paying ₹150 per bunch would become the norm.
Well, folks, this is what we call – inflation – the consistent rise in prices of goods and services in an economy. If the inflation rate is 5%, it means that on average prices of basic amenities are increasing by 5% every year. Inflation or price rise is beyond our control, how well we are prepared for its impact on our future financial health however, is within reach.
How is it calculated?
There is an official basket of ‘things’ which is considered as the standard for measuring inflation in an economy. Our basket in India has groups of things like food, fuel, housing, transportation and so on. Different items have different weights assigned based on their contribution to an average individual household. As the overall value of this basket increases every year, it translates to the inflation in the economy.
It is a fact that the recent spike in annual inflation from around 4.5% in 7.5% is contributed a lot by food prices, particularly vegetable prices.
Why does it matter?
Of course, not only does inflation matter because your daily expenses go up, but it also matters because over time inflation eats into the value of money. In simple terms, your ₹100 today is going to be worth ₹95.23 if the annual inflation is 5%. Every year, the value of money decreases by the level of inflation in the economy. While the basics get captured, there are items like higher education, urban lifestyle inflation which aren’t well captured but in reality, do impact the value of your money. Moreover, these items see price changing at a much higher rate, hence, the value of your money spent on this reduces faster.
Reducing the value of money is not an encouraging start to your money life, but it a reality!
What can be done?
You have two things which you can do and thankfully at least one is completely in your control. The first thing you should be conscious about is increasing your earning capacity annually too. This will enable you to earn more each year to combat the inflationary impact of price rise on your income. For example, if you earn ₹10 lakhs a year, next year if your income does not change, in real terms you are earning ₹9.52 lakhs, assuming a 5% annual income. You may still see the figure ₹10 lakh on your payslip but thanks to inflation it is worth only ₹9.52. Work hard and work smart so that your annual raise is at least above the rate of inflation.
Working hard is in your control but sometimes, in a weak economy, how much you earn may not be in your control. Sometimes due to other external factors or due to medical issues as well you may find that your earning capacity is limited. Hence, this first factor is controllable but not 100%.
The second thing you can do is invest your money wisely so that the returns you earn are higher than inflation. What you need to understand at this point is that in an economy like India where growth is positive, or in other words the size of the economy is increasing, there is going to be some amount of inflation or price rise always. At the moment given the economic dimensions, it is safe to assume that 5%-6% annual inflation is normal for India.
Hence, the investment return you need to look for is at least higher than that after any tax liability is deducted. A bank fixed deposit, for example, pays you between 6%-7% per annum, post-tax it comes to anywhere between 4.2%-6.3% depending on your tax liability. This is clearly not enough to beat inflation and make your money grow.
What you must do is choose growth assets like equity which have the potential to deliver 10%-12% returns per annum over long investment periods of 7-10 years or more. This is a sure way to beat the damage that inflation does to your money. You needn’t go all out in equity from the start; start slow and build it up over the years. What you must do is start NOW!
While higher onion prices may not cause that big a dent in your household budget, education expenses increasing 10% a year is likely to cause you pain. Inflation impacts all of us equally, those of us smart about managing it through growth assets will be rewarded with real wealth creation in the years to come. Understand this all-important concept early and stand to gain forever!