Inflation: The termite

Back in your college days, you may remember going to a restaurant and having a lavish meal for just about Rs 300. Today, when your kids are in college, they tell you that Rs 1,000 can barely get one a proper meal in a good restaurant even for a single person. This is inflation or simply put price-rise. Not only does the ever increasing inflation make things costly over time, it can also have a serious impact on your savings.

But how does that happen? The simple answer is that inflation makes currency lose its value. To understand this better, let's take a simple example. You want to buy an LED TV this costs (just for explaining purpose) Rs 100 today. But you decide to save for it this year and buy it the next year. So till then, you put your money in the bank, and let it grow interest. Even at a good rate of 8%, you will get Rs 108 back at the end of the year. However, let's assume that the rise in inflation was 10% and the LED television is now worth Rs 110. Thus to buy it, you would have to shell out an extra Rs 2 from your pocket.

Compounded inflation over the years can zoom past the interest rate offered by your bank, and within a few years, the product maybe well out of the grasp of your Rs 100. This is a clear example of how currency loses its value over time and is a serious problem faced by our economy.

We live in times, where inflation grows everywhere by almost 9-10%. Going at this rate, what you save today for your tomorrow might not be enough by the time it is actually tomorrow. Assuming a growth based on the interest rate on your investment is called a nominal return, in reality, you would have to take in to account inflation which when factored gives the Real Return on an investment. Thus, while investing money for the future, opt for instruments which provide a real return (and not a nominal return) on your money which is a return higher than the inflation.

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