The Impact of Inflation on Your Savings

Do you know? Inflation can be a silent wealth killer, slowly eroding the value of your savings over time. While keeping your money in a bank account or a fixed deposit might feel like a safe bet, inflation often means your savings won’t go as far as they once did. In simple terms, inflation is the rise in the prices of goods and services, which reduces the purchasing power of your money. In India, it’s measured by the Consumer Price Index (CPI), which tracks the price changes of essential items like food and fuel. Though the Reserve Bank of India (RBI) tries to control inflation, it’s a natural part of an economy, and if not addressed, it can significantly impact your savings.

Think about it! If you are saving in a savings account that gives you 3-4% interest, or a fixed deposit offering around 5-6%, that looks a little okay. But if it hovers between 5 to 6% easily out there, inflation means that your money is losing its value essentially speaking. For example, take the case of a person who has ₹1,00,000 in a fixed deposit drawing 6% interest at the end of one year. He will then hold ₹1,06,000. But with inflation at 5%, that ₹1,06,000 has only the purchasing power of ₹1,01,000 today. So, though the numbers look nice on paper, the actual value of your savings isn't growing much when adjusted for inflation.

Now, traditional savings avenues such as fixed deposits or recurring deposits are often claimed to be safe, but they do not figure among the finest options when it comes to beating the rate of inflation. But taking off inflation and taxes from that return, one gets to the conclusion of very meagre or even negative real return for quite a few cases. FDs and RDs are great for short-term savings, like building an emergency fund, but they don't help much when it comes to growing your wealth over the long term.

On the other hand, some assets tend to benefit from inflation. For instance, real estate can appreciate in value as high inflation raises the prices of property. All in all, this makes real estate an inflation hedge but may be very illiquid. According to the rule of thumb, normally gold acts like a hedge at periods of high inflation although returns are not as good compared to equities; It will really be able to keep up the value and sometimes go high in times of high inflation. But if one is considering the growth of wealth over the really long term with seriousness, the market-linked instruments like equity mutual funds start outstripping inflation. Equities have given out returns in excess of inflation generally, and definitely provide that compounding advantage that helps grow your money. You can also systematically invest on a regular basis through an SIP, wherein the irregularities in markets get reduced over time through averaging over time.

Another option is Inflation-Indexed Bonds, which are designed to protect your purchasing power. These bonds adjust with inflation and provide a return that helps preserve the value of your money.

So, how do you overcome inflation? The answer is: diversification. All your eggs should not go into one basket. Spread out amongst equities, fixed deposits, gold, even real estate.

Diversifying your investments helps balance risk and rewards, giving you a better chance to protect your wealth from inflation. Equity and mutual funds are excellent choices for long-term goals, as they’ve historically outperformed inflation and offer strong growth potential. For more risk-averse investors, real estate can be a good option, as property values tend to appreciate over time, and rental income can be adjusted for inflation.

If you prefer a no-risk, inflation-protected option, Inflation-Indexed Bonds are a great way to preserve your purchasing power while earning returns. These bonds adjust with inflation, ensuring your money retains its value over time.

Lastly, to stay ahead of inflation, consider increasing your income through side gigs or skill development, and boost your savings rate. Regularly reviewing and rebalancing your portfolio will help ensure you stay on track to meet your financial goals and protect your wealth from rising costs.

Conclusion

Inflation is a fact of life, but it doesn't need to chip away at your wealth. By diversifying your investments, investing in assets like equities, and taking advantage of inflation-protected securities, you can protect your savings and even grow them over time. Stay proactive, and you will be better prepared to safeguard your financial future against the creeping effects of inflation.