World Savings Day: Why is it important to factor inflation in financial planning

As the people around the world observe World Savings Day on October 30 , let us talk about how the inflation can eat up a considerable amount of your savings.

Inflation is often mentioned as a major economic threat as can intensify the conflict between income and expenditure. When making future plans, especially for investments that will provide you with income in retirement, inflation should always be taken into account.

The immediate repercussions, such as higher prices, come to mind when most people think about inflation. However, how does it concern investors?

When you retire in 20 or 30 years, the cost of living can be significantly greater. Consider the price of a piece of bread or a tank of gas 20 years ago. Your returns are decreased by inflation because of its nature. We can say that an investment of Rs. 1 crore made today would lose value over time due to inflation. Even if you receive the same retirement payout, your purchasing power will be lower.

Your investment and financial planning needs to take into consideration the fact that prices for goods and services fluctuate over time.

How does the inflation affect your savings?

Increased inflation results in higher prices for products and services. This implies that you will have to spend more to buy the same goods and services. We can say that while a sum of Rs. 20,00,000/- may be sufficient for your child's education right now, it might rise to Rs. 30,00,000/- in ten years.

READ MORE: 4 points to build a recession-proof portfolio that stays ahead of inflation

If there is a 6% inflation rate, then to guarantee that your savings can be enough to assist you reach all of your long-term financial objectives, such as your dream home, your child's education, your retirement, and much more, you will need to save an additional 6%.

Let us understand this with an example. Mr. Gupta has Rs. 1,00,000 today and he intends to buy a product worth the same price. Skip to same day, after 10 years. Let us see what happened to the price of that product and the amount that Mr. Gupta had.

Note: The above data has been compiled from https://www.iciciprulife.com/

You can see that as time goes on, your savings will lose value while your costs will keep rising. This is how inflation impacts your money and the cost of goods in your surroundings.

Inflation can impact your savings and how much you need to set aside for unforeseen financial crises along with changes in costs. Three to six months' worth of spending should be covered by a good emergency savings account. However, if inflation causes your spending to rise over time, you should increase your savings rate along with it, else you risk running out of money when you need it most.

READ MORE: Lifestyle Inflation: How does it eat up your wealth?

Based on your time frame and goals, your financial plan can assist you in determining how much risk you are comfortable with. You can make riskier decisions that could result in greater gains during periods of rising inflation. You might select a less hazardous strategy that helps you stay up with inflation while helping you preserve your gains.

A diligent investor may prepare for inflation, which is a normal occurrence in economies, by investing in assets that beat the market when inflation is high. One asset class that produces returns that outpace inflation is equity. Markets have historically outperformed inflation. Advisors also regard gold as a safe haven asset class.

Because increments in gold prices and their associated returns have historically been able to counteract inflation, it is employed as a hedge against it. Other options include buying real estate and purchasing government-issued bonds with inflation indexes. Your financial planner can guide you in your search for assets that increase in value and provide variable interest.