You are 30 – Think of 50: Impact of inflation on your budget

It is 2008, and you are 30 years old. You are in your prime, are progressing well, and life looks very comfortable!

What would the scenario be like in 20 years, when you turn 50? How would the prices of essentials be? How would your monthly budget (and expenses) be affected by price movements?

This article discusses these things, and tells you how to keep yourself away from financial trouble in spite of inflation.

First step to a solution – Recognizing the problem

So, let’s start by understanding the problem better. We would take some real-life figures to do this – hard numbers always convey things more effectively!

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Let’s have a look at the current prices of some of the essential day-to-day items that we use:

Since inflation is the culprit that is responsible for the price increases year after year, the prevailing inflation is the primary factor in any calculation for the future.

The current rate of inflation is around 12% per year. If we take this inflation, what would be the prices of these same things in 2028, when you are 50 years old?

Prices of some essential items, with inflation averaging at 12%

1 kg of sugar would cost Rs. 212 instead of Rs. 22 today, and 1 kg of rice would cost Rs. 289 instead of Rs. 30 today!! And we would see a similar story for all the items.

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But let me tell you that this scary picture is quite exaggerated: Although the current inflation is 12%, it won’t remain that high for all the 20 years we are considering.

This rate of inflation is quite abnormal – the rate of inflation has averaged out to around 6% for the past few decades.

So, for any long term calculation, we should take that into account, as that is the rate where we can expect the inflation to average out in the next 2 decades as well!

Prices of some essential items, with inflation averaging at 6%

1 kg of sugar would cost Rs. 71 instead of Rs. 22 today, and 1 kg of rice would cost Rs. 96 instead of Rs. 30 today. Prices of other essential items would also increase accordingly.

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Now, the picture is much more realistic.

That doesn’t mean the situation is comfortable – but since we have the correct data now, we can identify the problem correctly.

Understanding the problem

What do these figures mean? How does it impact you?

This simply means that you need to budget for a lot more just to maintain your current lifestyle!

Let’s see an example. Let’s consider the monthly usage of a hypothetical family:

As you can see, the cost which is Rs. 1,807 in 2008 would balloon to Rs. 5,795 in 2028. That is, the monthly budget would shoot up by over 3 times even if your consumption remains the same!! (It would be 3.2 times, to be precise)

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Tips on what you should do

The most important financial lesson to be learnt is that you should always keep ahead of inflation.

Income

The yearly hikes in your pay (or, the increase in dearness allowance – DA – for government and PSU employees) are meant to take care of inflation. Companies study the market, and take into account not just the competition but also the prevailing inflation while deciding these hikes.

Since these yearly pay increments are your primary weapon against inflation, you need to make sure that the hikes are more than the rate of inflation.

This might not be possible every year, but on an average, this has to be true if you do not want your effective income to reduce over time!

The major jumps that you get in your salary at the time of promotions are like bonuses – those are meant to increase your standard of living over time.

Investments

This is even more important than income, especially because you have total control over this.

Let’s say the inflation is 8%, and you invest in a bank fixed deposit (FD) that gives you 10%. Should you be happy?

Apparently, yes, because you are earning more then the prevailing rate of inflation. But how can we forget the all-pervasive income tax?

If you fall in the highest tax bracket of 30%, the effective post-tax return for you is only 7% – which is less then the rate of inflation!!

Therefore, you should choose your investments very wisely, especially in times of high inflation (like in August 2008, when the rate of inflation is more than 12%).

Where to Invest?

Stocks / Shares / Equities

If you are investing for the long term, equities remain the best investment alternative. (Please read “Stocks – The winning bet for the long term” and “Equity Investment is Risk Free – Here’s the Proof” to know more about it)

You can invest either directly in individual stocks, or can choose good mutual funds (MFs), but stocks remain the most attractive option for long term investment, and they always produce inflation beating returns.

(Please read “Direct investment in Stocks versus Mutual Funds” for more on this. Please also come back to read “Equity Investment is Risk Free – Here’s the Proof”)

Real Estate

Over a long term, real estate also provides good return that is inflation beating. But real investment comes with its own pros and cons, and is not for everyone.

Please read “Real Estate Investment” to read an introduction to investing in real estate.

Gold

For long term investments, gold remains a favourite for Indian investors! Although most of us invest incorrectly in gold (through jewellery), gold definitely is a valuable asset for long term investment.

To know more about investment in gold, please read:

• Shine matters – Gold is not old
• Have you “invested” in jewellery?
• Get the glitter – How to buy gold
• After e-Stocks, now its time for e-Gold – Gold ETFs

Alternatively, you can also download a free, comprehensive e-book that explains gold investment in detail.

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Others

Other possible alternatives – though not inflation beating – are:

• To invest in bank FDs giving the highest possible return
• To invest in government sponsored schemes like PPF, NSC, KVP, Post Office MIS, etc. for absolute safety

Other articles you might be interested in:

• An Introduction to Reverse Mortgage
• Home Loan / Mortgage Insurance – What to Buy, How to Buy
• Change in interest rate: Impact on floating rate home loan, EMI and tenure
• All you wanted to know about Senior Citizen Savings Scheme (SCSS)
• When “at-par” is not so good: New Fund Offer (NFO) versus existing MF schemes
• Not Cash, Not Travellers Cheques: Use Travel Card
• Once again, banks hike interest rates for deposits and lending (loans)
• SEBI approves Application Supported by Blocked Amount (ASBA) for IPOs
• Missed the income tax return (ITR) filing deadline of 31st July?
• How to fill Income Tax Return Form 2 (ITR2) Instructions
• Set Off and Carry Forward of Losses – Capital Gains and House Property
• How to save / avoid Long Term Capital Gain (LTCG) Tax on Sale of a House

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