Inflation is very important in day to day life and also it affects your investment returns in long run, so let’s see al about inflation in following sub sections.
What is Inflation?
Inflation is the term used to define the general rise in level of the price of goods and services in any economy which subsequently reduces the buying power of money.
The following two examples will clarify the meaning of Inflation
1. If you were able to buy one kg of Rice for Rs 8 to Rs 10 in 1980 and if same Rice you would be able to buy at Rs. 30 to Rs 40 in 2010 then it is happening due to rising inflation. So if inflation rises, each unit of currency buys fewer goods and services.
2. My grandmother is supposed to say that in Rs 1 they were doing shopping for a week.
Movie tickets price were Rs 2 to Rs 3 in 1980’s and now they are for Rs 100 to Rs 200.
Inflation kept on rising and the money value kept on decreasing.
“Inflation has really brought the value of our hard earned money down.”
How is inflation calculated?
The wholesale Price Index (WPI) is used to calculate the rate of inflation in our economy. WPI index uses whole sale prices of products instead of retail consumer prices.
What steps to be taken as Individual to take care of rising Inflation?
As the individual, the person need to look at investing, this would help us to take care of our investment and returns in future and provide us good returns to survive in rising inflation in future.
If you invest Rs. 100 in the market today and you get 6% rate of return then at the end of the year you will have Rs.106.
But, for example, if the rate of inflation is at 8 % then an item costing Rs.100 today will cost Rs.108 after a year. So what you can buy with today’s Rs.100, you will be able to buy same thing with Rs.108 after one year. So in such scenario 6% returns are not sufficient.
So the conclusion, the rate of return on your investments should be higher than the rate of inflation.
How to approach rising inflation and save for future
If you are planning to buy a product (product can be anything) at Rs 100 today will cost Rs 108 (at the rate of 8% inflation) after one year. So instead of Investing Rs 100 today invest more then Rs 108 today so that your investments and returns on that can take care from rising inflation.
History has shown that investment in equity markets has always provided good returns in long term like 5 to 10 years. So investment in strong fundamentals companies, growth oriented and proven mutual funds will provide good returns in long term.
Inflation and its Effects on your Earning
What are the causes of Inflation?
The following factors can lead to rise in inflation:
• Loose or expansionary monetary policy - If there is a lot of money going around, then supply is plentiful compared to the products you can buy with that money. The law of supply and demand therefore dictates that prices will rise.
• Increases in production costs
• Tax rises
• Declines in exchange rates
• Decreases in the availability of limited resources such as food products or oil, this is one of the major cause happening currently
• War or other events causing instability
What are the effects of Inflation on an economy?
Inflation has both Negative and Positive points which are as follows.
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• Add inefficiencies in the market, and make it difficult for companies to budget or plan long-term
• Can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates.
• Cost-push inflation - Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation.
• Hoarding - People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects.
• Hyperinflation - If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.
• Price inflation has immense effect on the Time Value of Money (TVM) - The above two examples explains the meaning of this statement.
• Labor-market adjustments - Inflation would lower the real wage if nominal wages are kept constant, Keynesians argue that some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster.
• Debt relief - Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate raises
What measures can be taken to control Inflation?
The central banks, monetary authorities or finance ministries of most nations have the authority to take economic measures to control rising inflation by regulating the following factors:
• Reducing the central bank interest rates and increasing bank interest rates
• Regulating fixed exchange rates of the domestic currency
• Controlling prices and wages
• Providing cost of living allowance to citizens in order to create demand in the market.
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