Impact of Inflation on Financial Goals and Money

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Jaya: Hello all – Welcome back to Kairos – The spirit of Kairos is to talk about doing the right thing at the right time for personal finance. This is Jayalakshmi and we have Namratha – chartered accountant from the planning team here joining us on our episode today! Hi Namratha.

Namratha: Hi Jaya, thanks for inviting me to the podcast today!

Jaya: My pleasure, Namratha. We have been witnessing rising inflation and this has become a growing concern for consumers around the world. It has also caused havoc in the financial markets, owing to fear and uncertainty about what happens next with interest rates, prices and economic growth.

So – today we are gonna be talking about the impact of inflation on financial goals and the time value of money.

Namratha: So true, inflation is a topic in everyone’s mind and it’s at rising since the last few months.

Jaya: Exactly – I’m sure most of us know that inflation ideally reduces our purchasing power. And we see the food, and fuel prices rise year after year – So How a rise in inflation impacts someone’s financial plan?

Namratha: Financial planning entails laying out your long-term financial goals and then creating a plan to move towards these goals. Inflation hits your financial plan on multiple counts. It impacts your future cost of living, it will affect the real returns that you will earn on your investments, and it will also have an impact on the way you plan for your future goals.

Jaya: For the benefit of our listeners, can you explain this concept with an example.

Namratha: Definitely! Let’s assume you put Rs. 1 Lakh in a deposit that earns 6% interest. At the same time, prices are going up at a 6% rate. In this case, the earnings from your savings will keep pace with the inflation rate. Now, let’s assume that inflation is higher than the interest rate you get on your savings, in this case, the value of your money goes down. You do not earn from saving. In other words, you lose purchasing power.

Jaya: I agree so in the second case where inflation is higher than the interest rate – the lakh that is in the savings will not be worth the same value. Apparently – Locking the money in investments that fetches lower returns doesn’t help much.

In fact, in the polls which we conducted on social media asking if inflation erodes money? Almost all of them voted saying that’s true – This is no brainer, and they believe it does reduce the value but as we see not many of them are sure on how to deal with it.

Namratha: Yes, inflation does affect your standard of living – It has a direct effect on your spending power.

Jaya: Absolutely. So, what effect does it have specifically on long-term & short-term financial goals?

Namratha: When planning for long-term goals, it is essential to be aware of the cost of achieving that goal. Most of the time when we think about a future expense, we assume that we will be okay because we have X amount saved. But we almost never consider inflation. The impact of inflation needs to be taken into consideration when planning future goals, while creating future spending plans, and while developing financial investment strategies.

If there is a 7% inflation, you will need to save an additional 7% to ensure that your savings is sufficient and that it can help you achieve all your long-term financial goals – like your dream house, your child’s education, your retirement, and much more. This is why you should always consider inflation while planning and start investing your money in financial instruments that can offer you higher returns to counter the effects of inflation.

Jaya: When we talk about long-term goals – like retirement, what should we do to protect our retirement savings or while building this corpus?

Namratha: Inflation is one factor that plays a vital role in analysing requirements during retirement years. Since the value of money decreases with time, it shoots up our expenses every year, which is indicated by the inflation rate.

And when you plan your retirement, which is 20-30 years down the line, your monthly expenses are expected to be way higher in the future than it is today if we consider this yearly inflation. So, to arrive at an effective estimate of your financial requirements during retirement, you must apply an approximate inflation rate while calculating the retirement corpus. Medical and healthcare expenses will also be higher by the time you plan to retire. Hence, estimate the future medical costs considering inflation and your age when you may need extra medical care and support.

We posted a poll on our socials to understand from our listeners whether they think health care becomes more and more expensive over the years because of inflation. Surprisingly, 92% of the people believe it will impact healthcare expenses as well. This is evidence enough that factoring inflation while arriving at your medical corpus is equally important. This draws down to the point that planning for retirement without accounting for inflation could result in an undesirable outcome post-retirement.

Jaya: So, Namratha, we have spoken extensively on why it is important to factor in inflation. But how can we protect our investments from inflation? Can you throw some light on this?

Namratha: Sure. Inflation is a natural occurrence in an economy, and a disciplined investor can plan for it by investing in assets that outperform the market during inflationary climates.

When we asked our listeners about which asset class they believed would help generate inflation-beating returns in the long run, 32% of those who answered believe both equity and gold can help in generating inflation-beating returns. Which is indeed correct.

Equity is one asset class that generates inflation-beating returns. In the long run, markets have beaten inflation. Gold is another asset class which is considered haven by advisors. It is used to hedge against inflation because increases in gold prices and the returns thereof have been able to offset inflation in the past.

Other alternatives could be Real estate investments and Inflation-indexed bonds issued by the government for beating inflation. All this said it is important to speak to your advisor before going all in on only one or two investments. A good advisor will help you invest in the right avenues, at the right time, based on your risk appetite and help you make the best of every market opportunity.

Jaya: Thanks Namratha. In the current scenarios do you think one should review their portfolio and financial plan? How crucial is it

Namaratha: Of course! Reviewing your savings and preparing for inflation changes is important. That may include saving more than you think you need; increasing stock holdings in your portfolio; and having short-, medium-, and long-term investment strategies that adjust when inflation is high.

Also, you may want to review your investments at least once a year to understand how your investments are doing. Your financial advisor can help you with rebalancing, which can help restore the mix of investments back in line to achieve your financial goal.

Another important thing an investor needs to consider before parking their surplus funds is diversification. There’s a very famous saying- “Don’t put all your eggs in a basket”. It means that the portfolio must be diversified.

Jaya: I had a few key takeaways from the conversation. Let me summarize:

• • • • 1. Inflation impacts money and financial goals, hence having inflation factored in for your goals, will help in building a bigger corpus to sustain the inflation levels in future.
        2. As you factor inflation into your retirement planning, risk and unexpected volatility are always possible. But having strategies to minimize their impact and protect your savings can help you feel more prepared and confident in your future
        3. Inflation hedging can also help protect the value of an investment. A disciplined investor can plan for inflation by cultivating asset classes that outperform the market during inflationary climates.
        4. Conventional asset classes such as real estate, gold, etc., can be viewed as inflation-proof investments.
        5. Before investing, you must be aware of the various alternatives available to you & how those alternatives work.

As the famous saying goes, “risk comes from not knowing what you are doing”. And An informed investor always has a lower risk of losing his money. So, stay informed and safe!

Disclaimer: The contents of this podcast are for informational & educational purposes only. Speak to your advisor before making any financial decision.

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