Inflation occurs when the price of goods and services in a country rises, whereas deflation occurs when the price of goods and services falls. The two sides of the same coin are inflation and deflation. It is critical to maintain a balance between these two economic circumstances because the economy may swiftly swing from one to the other as a result of these two conditions.Let us understand it in detail.
What is Inflation?
Inflation is the gradual loss of a currency's buying value over time. The increase in the average price level of goods and services in an economy over time may be used to calculate a quantitative estimate of the pace at which buying power declines. A rise in the overall level of prices, signifies that a unit of money now buys less than it did previously.
In an inflating economy, if mangoes cost Rs.100 per kilo in 2011, they will cost more in 2020. Let's suppose mangoes in 2021 retail for Rs.200 per kilo. As a result, whereas you could purchase 10kg of mangoes for Rs.1000 in 2011, your purchasing power would dwindle by 2021, and you will only be able to buy 5kg of mangoes for the same price.
What effects does Inflation have?
As commodities and services become more expensive, a currency unit's buying power declines. This has an effect on a country's cost of living. When inflation is strong, the cost of living rises along with it, resulting in a slowdown in economic growth. In order for spending to be encouraged and saving to be discouraged, a certain degree of inflation is essential in the economy.
What are the major causes of Inflation?
One of the key causes of inflation is an economy's excess money supply. This occurs when a country's money supply/circulation expands faster than its economic growth, lowering the currency's value.
When people's disposable income rises, their demand for products and services rises as well. The increase in disposable income may be due to a gain in national income, tax reduction, or a drop in people's savings.
Developmental efforts and social welfare programmes have prompted the government to extend its operations. This is also a factor in the increase of the prices.
Because of corruption, tax evasion, and other factors, there is more black money which increases aggregate demand. People lavishly spend this money and the supply of items is reduced through black marketing and hoarding. These patterns tend to push up the price level even higher.
What does it mean to “beat Inflation”?
To beat inflation, an investment must provide better returns than the rate of inflation in the economy. Your returns will be invalidated if the rise in price levels is more than the returns you are receiving.
Let's look at an example. Assume you put ₹100 into an investment that yielded 4% over the next year. Your investment now has a value of ₹104. Assume, on the other end, that the economy's inflation rate is 5.5 percent. Your return on that investment is lower than the rate of inflation, thereby cancelling out the gains you made.
How can we overcome inflation?
Enhance your earnings
Consider a scenario in which the rate of inflation is 5%. A person named X works for an IT firm. He enjoys playing guitar and is quite skilled at it, in addition to his full-time work. He finds an hour each day and begins to teach people how to play guitar through the internet. Per student, he charges Rs.1000. As his fame develops, so does his income from his side hustle, which will reach Rs. 20,000 in a year.. In other words, his income increases by 20% while inflation rises by 5%. The rise in income is greater than the rate of inflation.
Investing in stock market
Stock markets have outperformed inflation in the long run.. As of April 15, 2021, the Sensex has returned almost 88 percent CAGR over the previous five years.This demonstrates that, in the long run, stock markets recover. Risks and losses balance each other out. Stock market investments that are goal-oriented and well-researched can help you overcome inflation.
Investing in Mutual Funds
Equity mutual funds are a good option for individuals who don't want to invest in individual equities. There are several sub-categories of equity funds that can cater to the needs of various types of investors. There are market capitalization-based equity funds, sectoral funds, equity funds based on investment methods, tax-saving funds, and so on. As of April 2021, most equity fund categories have 5- and 10-year returns of more than 10%.
Investments in Gold
Experts all across the world regard gold to be a "safe place." The increase in gold prices and returns have been able to balance inflation and hence it is used as a hedge against inflation. According to a World Gold Council research, a 1% increase in inflation leads to a 2.6 percent increase in gold demand, and an increase in demand for practically everything leads to an increase in price.
Avoid lifestyle Inflation
Maintain a basic and consistent lifestyle. We must recognise that the world around us is attempting to persuade us that we must keep up with all of the latest trends, get all of the latest sneakers, purchase the newest iPhone, and attend weekend parties. Keep in mind that the costs connected with all of them will escalate over time. As a result, stay away from such fast-moving trends and spend your money with extreme caution. This is a simple technique to avoid lifestyle inflation.
While inflation is a cause of concern for the economy, it does not affect everyone. It is a boon for a certain set of people. Inflation diminishes the purchasing power of consumers, but it rewards investors. If you invest in inflation-affected assets and hold them for a long time, you will almost certainly profit. Hence, understanding all the aspects of inflation may give you a chance to benefit from it.