Inflation is the first thing that all of us should know on the subject of wealth management. It is very surprising that most educated and learned persons /investors still do not fully comprehend the term Inflation and it's impact on us. Ronald Reagan, the 40th US President, once said that "Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man". There are a lot of things that we can learn about Inflation and things related to it. In this piece, we attempt to present a simple FAQ on the subject.

What Is Inflation?
Inflation in simple terms means general price rise of goods & services. In economics, Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. In other words, the real purchasing power of currency reduces due to Inflation. As Sam Ewing once said "Inflation is when you pay fifteen dollars for a ten-dollar haircut you used to get for five dollars when you had hair".

How Is Inflation Measured?
Inflation is usually measured based on certain indices and broadly, there are two categories of indices for measuring Inflation i.e. Wholesale Prices and Consumer Prices. For measurement, an index number or a single fi gure is arrived at that shows how the related basket of goods & services has changed over time. Thus we have the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) as the two major indicators of Inflation. The Inflation rate is the annualised percentage change in the index over time.

CPI (also retail Inflation) = Measures changes in the price level of a market basket of consumer goods and services purchased by households. It is the Inflation which is borne by us as individuals.

WPI (also headline Inflation) = Measures changes in the price level of a representative basket of wholesale goods which are traded by producers. It is the Inflation at the level of producers and has more meaning to industries & manufacturers. It is measured more quickly than CPI which takes more time to get reflected in the index. Different countries have different methods of measuring Inflation. In India, like many other developing countries, uses the Consumer Price Index (CPI) as it's central measure of Inflation. Previously India used Wholesale Price Index (WPI) as the measure for Inflation but since year 2014, the new CPI (combined) is the new standard.

What Are The Reasons For Inflation?
There are several factors that affect Inflation in an economy and it is not easy to identify the exact relationship between different factors and it's impact on Inflation. For the sake of simplicity, we will broadly take a look at the primary factors for Inflation here...

Demand factors: It happens when the aggregate demand exceeds the aggregate supply. It is a situation where too much money chases few goods. Increased money supply due to loose monetary policy and low interest rates results in Inflation. Fiscal deficit financing by government by way of printing more money also results in Inflation.

Supply factors: It happens when the aggregate supply is not able to meet the aggregate demand. It is a cause of Inflation in an agrarian country like India where food is a major component of CPI. Further, because of rising wages & cost of capital also impacts the production cost of goods & services leading to rise in prices.

Domestic factors: In addition to demand & supply, the quantum of spending by government in the economy directly a ffects Inflation. Further, higher employment levels, taxation rates, etc. also add to Inflation. Issues like hoarding, blockages, etc. also positively impact Inflation.

External factors: There are external factors like currency exchange rates, trade barriers, etc. which a ffect the price of imported goods. Commodity prices in international markets like crude oil, gold, etc. also has impact on domestic Inflation.

How Does It Affect Us?
Inflation affects us directly and indirectly and has both positive and negative impact on us. While we may not list every type of impact, here are a few ways in which we may get affected as investors.

Purchasing power: Inflation hurts our buying power since we will have to pay more for same goods & services. Thus, with an Inflation of say 8%, your 1 lakh rupee today will be worth only R46,319/- in ten years time.

Cost of living: The cost of living is not equal to Inflation but is an aggregate impact of Inflation in our day-to-day lives. With Inflation, our general cost of living will increase and unless we are o set by rising income by the same rate, we will have increased expenditure and reduced savings. It will mean that one financial goal today will be worth lot more in future. For eg., when planning for retirement after say 25 years, your 50,000 worth of monthly expenses would rise to over 3.42 lakh rupees at an Inflation of 8%.

Wealth Creation: If your investments are not earning you more than Inflation then you are not actually growing or creating wealth. To create wealth you need to generate more of 'real returns' which we will talk later.

Interest rates: In case of sustained periods of high Inflation, the government is likely to keep interest rates higher meaning that loans will be at higher rates while rates of deposits will be also kept higher to absorb money. There will be less of government spending in general. In periods of low Inflation, interest rates will subsequently fall and this may also lead to a fall in interest rates offered by small savings /deposits making it a challenge in retirement planning.

Housing & stocks: In general, if you have already have investments in housing /stocks/equity mutual funds before Inflation, you will be in position to benefit from Inflation when prices rise. However, if not, you will find them expensive to buy later.

What Are Real Returns?
As investors, we should always look at returns not as notional returns but as real returns. Notional or stated returns is what you receive but real returns is what you are getting in real terms – after removing Inflation. For eg., if a bank account is giving you 8% pre-tax returns yearly – even with conservative retail (CPI) Inflation of say 7%, you are only getting 1% returns. If you consider post-tax (30% slab) returns of 5.6%, then your real returns are a negative of 1.4% meaning that you are loosing money by investing in such an avenue.

Next time whenever you are evaluating investment decisions, please remember real returns. Going a step further, it will be great if we calculate post-tax, real returns between investment avenues /products for our investment horizon.

How To Get Protection Against Inflation?
First, be aware of the Inflation figures and their impact in future costs. But merely knowing Inflation and real returns is not enough and we must also act to get protection against Inflation. Here are a few things that we should do in order to get protection...

Do Goal planning: Inflation is at the heart of financial planning. You must get to know your future financial needs to fulfill your life goals/dreams with the 'right' Inflation figure. The right Inflation rate is critical since CPI cannot be applied in general to all financial goals. For eg., Inflation for education and medical treatments is observed to be over 10%.

Save & invest aggressively: Merely planning is not enough and you also would need to aggressively save money and invest money. This means reducing expenses and controlling your budget.

Get Real Returns: Investments have to be made in asset classes /products giving you the maximum post-tax "real returns" as per your risk profile. The case is strongly in favour of equity asset class which has no long term capital gains (over 1 year) and where long term returns (at least 5 years) potential is the highest (average 12-15% expected) among all asset classes. This means that even at 12% nominal returns you are getting 5% of real returns vs. 1.4% of negative returns in fixed income instruments with 8% pre-tax returns.

Conclusion:
As Milton Friedman once said, "in¬flation is taxation without legislation". And there is no escaping it and no magic wand to keep it tamed and friendly for you. Infl¬ation impacts our financial lives more than anything else and we have to understand how infl¬ation would impact our future finances and financial goals. Understanding though is only the first step and protection is the next step where we must learn to interpret figures in terms of real returns and aim to maximum same. Unless we do not start doing that, we will keep eroding and loosing the our wealth without even knowing.

“Life is a game; and money is how we keep the score”

There is a very popular ad by MasterCard, wherein a young man's parents visit him,

The cost of business class tickets is Rs 110,000,

He rents a luxury car, cost is Rs. 8,000,

He takes them to an amusement park, cost Rs 5,600.

And the old couple is on a ride laughing their heart out,the ad says “ watching your parents become children again, 'Priceless'. ”

If someone told you, “Money can't buy happiness”. He probably wasn't entirely speaking the truth. The ad clearly highlighted that the young man had spent Rs.123,600 as cost to have that priceless expression on his parent's face. The underlying universal truth today is simply this - there are only a very few things that money can't buy and for everything else, there is money!

One can easily imagine doing many small things that gives happiness but doesn't cost us like spending quality time with family, watching favorite TV shows, waking up late on Sundays, chilling out with favourite buddies, going for a mountain trek, sitting on a beach on a beautiful evening and so on... True these things do not cost us but can we imagine us doing all these activities in absence of any money? The truth is that we all would fail to see and appreciate life's small moments and wonders if we don't have any wealth. We can live a normal, peaceful life absent of any worries only if we feel that we have financial security and well-being. In absence of same, we will see ourselves toiling day and night to earn money to fulfill our basic needs and our life's primary goals.

We all want financial freedom in our lives to do the things we like most but yet, most of us often spend a life time running a rat race to reach there. And when we reach that state, if at all we do, we would have become old to do any of that.

So what's the answer?

There is no magic wand, but all we can say is that we need to commit ourselves with all our will to aggressively save and be strict in observing wealth creation and management principles which we have so often iterated.

We need to start with basic money management skill of controlling expenses – a very important need today. We need to realise that spending money will grant satisfaction, it may however not last forever but spending money wisely will grant satisfaction that may last a lifetime. What you do with your money, matters more than how much you have. If you spend on things that give you satisfaction, it is really worth it. But if you spend on things that give you immediate pleasure but lose its lustre after some time, will not give you happiness. The idea is not to compromise on your needs or desires or to not follow your passion. It is about managing your expenses intelligently, so that you have a surplus which you can invest for your future.

It is wise to buy experiences and not articles.

You like cycling, plus its good for your health. Now there are three cycles to choose from, A,B and C, costing Rs 5,000, Rs 25,000 and Rs 100,000 respectively. Cycle A may not be very comfortable, so you might want to choose between B and C. A smart investor would always choose B because; Cycle B would maintain it's quality and comfort, it would have all features which are required for a comfortable cycling experience. It might not however be a big brand as C, it might have 2 lesser gears than C, Cycle C would be made of carbon, so you can lift the cycle with one finger. But does this really matter? Will it at all impact his cycling? No. So, he would rather buy Cycle B, save Rs. 75,000 and invest the money for his future. And there are hundreds of instances, where we have to make a choice between similar products but with different prices, or between buying or not buying at all. It depends on how wise we are and how effectively we follow money management techniques in each purchase; it will be a significant sum at the end of the year.

This first step is most critical as it will enable you to save money which can then be invested in avenues which help grow your wealth. Remember a rupee saved is a rupee earned. For some even such small savings can give happiness when they believe in their hearts that these savings will bring many smiles in future …

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Prerna has been working for 5 years now. The reason behind her slender investments is saving some tax, and some, she is generous enough to give away to the government for the economic development of the country. As far as her economics are concerned, she believes travelling and shopping in the mall till her last breath, are the only possible avenues where her hard earned money should go.

Prerna's investment summary:
2011 – Company EPF – Rs. 16,000 (She wasn't falling under a tax slab)
2012 – Company EPF – Rs. 24,000 (She joined the 10% league and paid some tax after the EPF)
2013 – Rs. 25,000 Bank FD in XYZ bank; Company EPF Rs. 24,000 (She paid Rs 9,000 in taxes)
2014 – Rs. 40,000 Bank FD in XYZ bank; Company EPF Rs. 24,000(She still paid Rs 16,000 in taxes)
2015 – Company EPF Rs. 24,000 (Since she got married, she had nothing left to invest; She paid Rs. 37,000 in taxes, as she entered the 20% slab this year)

Prerna could have saved her entire tax liability over these five years by investing smartly. Prerna after 5 years of employment has negligible bank balance, Bank FD's totaling Rs. 65,000 and EPF which she can't withdraw. She has entered into a new phase of life and is witnessing responsibilities falling one after the other on her head. She has realized that it is high time, she must get her act together and do something about her savings and investment. In fact, she has been thinking about this since 2013, but never took the pains to plan her finances. Prerna must follow these basic steps to step out of her dilemma:

• Educate yourself: The first step to investing is learning. There are various websites and journals, which host a powerhouse of information. Subject books on finance and government websites can also be referred. Prerna should familiarize herself with the basics of importance of saving, various investment options available and pros and cons of each. The advantage of acquiring knowledge is she won't be totally boggled when she takes the first step, there would be lesser chances of her falling into the trap of frauds, and her homework will be done when she seeks professional advice.
• Find your style: Though there are idol investment portfolios on the basis of age, income, family demographics, etc., but every individual has a different approach to life. Some may have the adventurous spirit and the aptitude to take risk, while others may be conservative and don't want to risk their money at all. So, Prerna should analyse her style, whether she wants to experience the thrill of equities or want to first build a safe harbour and then start exploring other options.
• Ice Breaker: Prerna has to shake herself up, since she is too comfortable with not bothering much for her future. She has been wondering that she wants to invest but kept on postponing. Procrastinating investments is delaying her financial security, all she needs is a "Start" button, she needs to lay the first stone in her investment plan.
• Start early: If Prerna would have started saving in 2011, she would have saved Rs 62,000 of taxes, that she paid, she would have saved at least Rs 3 – 4 Lac by now for saving these Rs 62,000, and if she directed small portions in monthly SIP's or RD's, she would have saved another Rs 1 – 2 Lac. She would have had a strong financial cushion for her now. However, better late than never, she should immediately start investing and make up for what she never did.
• Don't pay tax when you can save them: Prerna's taxes are equivalent to her total savings. The government has given us the benefit to not pay tax by saving for us. It has two benefits; one, we can save money by not paying tax and two, we are saving for our future in order to not pay tax. Rs. 150,000 can totally be saved under Section 80 C by investing the same amount and there are other sections as well, which can be used if applicable.
• Advice: Since Prerna is an amateur, she can make mistakes. She tends to get carried away, she may start doing, what her smarter friends are doing. She may start following what the anchor of the business news channel is saying without any research. Since she lacks exposure, she must seek professional advice. She may look up to an experienced family member, who is into savings and investments, or she may seek help from a professional financial advisor.

The advisor will help Prerna choose the right fit according to her profile and requirements. And all she needs is dedication, a control over her emotions and keep her basic necessities and investment commitments at the top. Let's bring a smile on Prerna's cute face by assuring her that she can continue shopping and traveling after providing for the above.

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