Here's how inflation impacts your savings

Introduction:

Inflation is the continuous rise in the prices of goods and services. It is also the simultaneous decline in the purchasing power or value of the currency – in India's case, it is the rupee. Inflation is a non-stop process and affects everything – from the cost of a t-shirt, movie ticket, college education, or property. On an everyday basis, it might be easy to miss the ripples of inflation, but when you look in retrospect over a particular period of years, you will be able to see the price hikes in various goods and services. To recognize that inflation is always at work is to realize that it can negatively impact your money. Here is how inflation works behind the scenes.

What causes inflation?

Inflation is caused due to various factors. Sometimes, it is due to the increase in the cost of production of raw materials or employee wages. Other times, it is because of high consumer or public demand of a specific product, goods, or service and the consequent low availability of the goods or service. It can also be due to a nation's poor economic performance or growth, which causes the cost of commodities to inflate. At the same time, people's incomes remain the same, or worse, reduced over the years due to high competition in the job market and unemployment rates. Irrespective of the reason, it is the regular working person who has to suffer from the consequences of inflation, as it is the one spending.

How does inflation affect your savings?

When the consumer or regular working person earns, they also save their money for emergencies and ticking off financial goals. However, inflation can tar one's good intentions and actions of saving by eating away at the value of their money with time. Saving money is a great way to avoid overspending on unnecessary items. But it provides little to no cushion against inflation. For instance, you save your money in the bank, and the bank offers you with an interest rate of return at 5% per year. But when you look at the present inflation rate in India, it is around 5%. That means  inflation would eat into your returns. Sometimes, the inflation rate can even touch 12%*, as seen in 2013. With such high ratios, there is a risk of your money entering a deficit. Only saving and earning minimal interest on your savings cannot hedge against inflation.

How to avoid the effects of inflation?

There are only a few assured ways of negating the effects of inflation and all of them are through calculated investments. Investing is a way of increasing your income over a prolonged time by putting your money into a profit-generating asset or instrument. It requires time, money, and patience but can reap high returns. To combat inflation, two types of investments can help:

1. Market-linked investments

Market-linked investments are those investments that depend on the performance of an underlying asset. These assets are equities, debt, commodities, indexes, mutual funds, stocks, securities, bonds, unit-linked insurance plans, foreign currency, and other financial instruments. Every market-linked investment carries a certain level of risk – low, medium, or high. But investing in them can help you multiply the initial sum of money you invest by a large margin.  

2. Physical asset investments

Physical asset investments are those investments that involve tangible (things you can feel) commodities. These assets can help combat inflation and have a history of yielding consistently high returns over the past. They include precious metals like gold and silver and immovable assets like real estate/ property. Gold, silver, and property are those assets whose demand seldom decreases due to the value attached to owning them. They can help you create long-term wealth and profits.  

Conclusion:

Inflation is that unpredictable force of life that will always be at play. However, you can always choose to negate its effects by being active in your investments and financial choices. The solution is not to shrink and compromise on your needs but to think and act big through consistent saving and investing. 

*12% (source – Times of India as of 12^th Dec 2013)

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