Assuming the rate of inflation is difficult, because you would need to define it for the life of your goals - 23 years for goal 1 - which is a very long time!

You know that the current rate of inflation is around 3.25%. But you also know that this is around the historic lows, which means that it may not remain 3.25% for the entire 23-year period you are considering.

Since the average inflation for the past few years has been around 5%, you assume that the inflation would average 5% during this 23-year period too.

Since the purchase of car is just 4 years away, you assume a rate of inflation which is closer to the current inflation rate. Also, you don't expect the cost of cars to rise too much due to the increasing competition. So, the rate of inflation for this goal would be 3.25%.

Having decided the rate of inflation, you now need to find out the cost of achieving your goals at their target dates. For this, you need to use the compound interest rate equation:

Amount = Principal * [{1 + ( Rate / 100 ) } ^ Years ]

For us,

Principal = Cost today
Rate = Assumed rate of inflation
Years = Years till the achievement of the goals

Using this formula, we arrive at the following figures:

I am sure this would prove to be an eye-opener, as you realize how inflation wrecks havoc on your targets, especially the long-term ones!

That's why I believe that compounding can be the most powerful friend when used wisely in the form of starting investments at a young age, but at the same time, can be the most devastating enemy in the form of inflation for long-term goals.

Step 5: Determine the after-tax rate of return for investments made today

This is another assumption you need to make - how much your investments would return if you invest today? Also, it is important to assume an after-tax rate of return, because that is what you get in your hands for spending!

The rate of return would depend largely on the type of investment.

Since the goal of buying an apartment is 23 years away, you can very safely invest in stocks, as stocks give the best rate of return in the long term. Historically, stocks have returned 15% - 20% returns over the long term, so you assume that you would be able to achieve around 18%. Since there is no long term capital gains tax on stocks, your post-tax return would also be 18%.

The goal of buying a car is only 4 years away. This is a very short time to invest in stocks for a goal - short term volatility in the stock markets could eat into your returns, and you may not be able to get enough to buy a car. So, you decide to invest in bank FDs which give around 9.5% per year. Since you fall in the top tax bracket, and pay 30% tax, your post tax return from the FDs would be:

9.5% - (30% of 9.5%) = 6.65%

(Continued on the next page...)

Other articles you might be interested in:

• Direct investment in Stocks versus Mutual Funds (MFs)?
• Are ULIPs a costly form of term insurance plus MF investments?
• ULIP v/s Endowment Plan for Life Insurance
• National Savings Certificate (NSC)