Thursday 22 May 2008

Inflation - A Powerful Enemy!

Inflation - A Powerful Enemy!

Dear Friends,

Prudent and traditionally conservative middle class Indians tend to spend within their means - Their typical monthly expenses are less than their monthly income and the balance is saved. Usually, (in over 85% of Indian households,) the amount thus saved is parked in banks, small savings schemes and gold (jewellery).  (The not-so prudent Indians actually live it up and freak out, usually with the help of plastic money - the ever-so-easy-to-get credit cards. This post will not focus on this latter group, but only on the prudent folks).

Saving a part of one's income is smart and wise. However, parking those funds in banks, small savings schemes, gold jewels, etc. is certainly not so wise. The reason: Inflation. Let us understand this in simple terms with a hypothetical example of a household that saves Rs. 5000/= per month and buys jewels worth Rs. 20000/= per annum and invests the balance amount of Rs. 40000/= per annum in bank deposits, postal monthly-income schemes, etc., and see what happens to the savings over a period of time.

The jewellery that's bought is almost never sold in one's life-time. While it gives a certain quantum of pleasure and satisfaction to us when we wear those jewels, beyond a point, most of these jewels only land up in bank lockers (for which we spend some more money). In any case, they certainly do not generate any "current income" nor do they generate "capital gains" unless and until they are sold (which, as we mentioned above, rarely happens in one's life time.

The amount invested in banks, postal savings schemes, etc. fetch, on an average, an income of around 8-9% per annum, which is taxable. Net of taxes, the returns are even lower. However, if one analyses our typical expenses, we just have to look around to see the extent to which prices increase every year. Some examples:

Nature of Expense

Approximate Prices

in rupees

% increase

in 2 years

June 2006

May 2008

Monthly rent of a 2-bedroom flat at a decent location in a metro (other than Mumbai / Delhi)

4000-5000

8000-12000

100%

Branded refined oil (per litre)

50

75

50%

Petrol per litre (despite the govt. not raising prices in proportion to increase in international prices)

30

50

67%

Tur Dal per KG

30

50

67%

Movie ticket (balcony) at a decent theatre

50

100

100%

Cost of dinner for two in a mid-range restaurant

150

250

40%

Minimum price of peanuts at the beach

2

5

150%

Of course, some of these prices will be wrong / overstated in certain cities. However, the general trend is more than visible. For most of us, our income levels are not increasing at the rate at which expenses are increasing. Obviously, we need to do something extra to bridge the gap.

Interestingly, prices of some other items have reduced over the past couple of years (like phone bills, electronic gadgets, etc.). Unfortunately, this has not resulted in any real reduction of expenses. Instead, our frequency of upgrading the gadgets, the number of minutes spent on the phone each day, etc. have increased dramatically, more than offsetting the impact of reduction in prices.

Taking into consideration the above, the returns generated by investing our hard-earned money in banks, postal savings schemes, etc. is far from adequate. Inflation, indeed, is a very powerful enemy.

Obviously, we need to:

  • become aware of the power of inflation to reduce our effective disposable incomes
  • identify better avenues to invest our savings so as to increase the rate of return beyond inflation levels
  • implement any suitable ideas that we come up with.

More on these in later posts!!!

Regards,

N


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