Inflation is the increase in the prices of goods and services over time. simply put it increases your cost of living and reduces your purchasing power. That means you have to spend more to fill your gas tank, buy a litre of milk, or get a haircut.
Since almost all of us have tracked the inflation data put out by Governments I won’t get into the CPI(Consumer Price Index) vs PPI (Product Price Index) argument because even your neighborhood paanwala will tell you its all bakwas ! When the price of onions moves from 5 Rs to 40 Rs that’s just plain painful for all! The long and short of it ,inflation is a misery index – as prices rise, your money buys less. That reduces your standard of living over time.
What causes inflation? The most common is demand-pull i.e. when demand outpaces supply for goods or services. Buyers want a product so much they are willing to pay higher prices. Cost-push inflation is the second cause. That’s when supply is restricted but demand is not. As a result, too much capital chases too few goods. It creates inflation by triggering either demand-pull or cost-push inflation. Another way of looking at the money supply effect on inflation is the same way collectors value items. The rarer a specific item is, the more valuable it must be. The same logic works for currency; the less currency t in circulation, the more valuable it will be. So when Central Banks print new currency, they essentially water down the value of the money already in circulation.
It may surprise most people, but economists generally argue that some inflation is a good thing. A healthy rate of inflation is considered to be approximately 2-3% per year. The goal is for inflation (which is measured by the Consumer Price Index, or CPI) to outpace the growth of the underlying economy (measured by Gross Domestic Product, or GDP) by a small amount per year.
Like aging or weight gain, the effects of inflation are both gradual and profound. Inflation creeps up on us over time, and as we continue our normal spending and consumption habits, the almost imperceptible increase of consumer prices doesn’t seem to make a huge difference in our day to day finances – which means it is all too often vastly underestimated. The effects of inflation are huge. And it doesn’t just affect areas like our salaries and the cost of purchasing a new home. Inflation hits us from every angle. Food prices go up, transportation prices increase, gas prices rise, and the cost of various other goods and services skyrocket over time. All of these factors make it absolutely essential that you account for the huge impacts that inflation can have on your long-term savings and ability to fund your golden years of retirement. If incomes do not increase along with the prices of goods, everyone’s purchasing power is effectively reduced, which can in turn lead to a slowing or stagnant economy. Moreover, excessive inflation can also wreak havoc on retirement savings as it reduces the purchasing power of the money that savers and investors have squirreled away..
The single most important consideration that inflation introduces into your financial planning process is: Factoring for inflation, how much will I really need to retire? What can be done to combat inflation’s detrimental effects on savings and adjust your portfolio for inflation? Contrary to public belief or opinion, we aren’t helpless in combating the role inflation can play in our lives. Many strategies can act as a hedge against inflation, but these techniques must be employed strategically and effectively in order to take advantage of their benefits. Some of these are simple :
• Spend money on long-term investments.
• Invest in commodities- gold and precious metals, real estate, collectibles, art.
• Consider dividend-paying stocks.
• Save more, or invest more aggressively.
Like it or not, inflation is real. Ignoring the effects that inflation can and will have on your long-term savings is probably one of the biggest mistakes that many investors make. Understanding the detrimental causes and effects of inflation is the first step to making long-term decisions to mitigate the risks. But the next step is taking action. to help you overcome the devastating effects inflation can have on your future retirement.
About the Author: Rahul Goel– A young graduate from Les Roches Bluche-Switzerland graduated in 2016, having specialised in Marketing and Entrepreneurship joined his family business after working in the United States for a span of 12 months. Currently managing over 50 HNI’s Rahul is helping dynamic young millennials build their runway to financial freedom.