In order to offset the impact of inflation, you need to save for the inflated cost and not at today’s cost of the goal.
To start saving for a long term and create a sizable corpus, there are several things that you need to do in tandem. You not only have to start saving early, but also build a portfolio in line with your goals with proper asset allocation.
If you want to invest for meeting your long term goals, another important factor you should not ignore is inflation. The rise in prices keeps pushing the cost of goals higher and by the time you are ready to meet the financial goal, its cost could have gone much higher. It means, the purchasing power of the rupee keeps coming down due to inflation.
For example, if you are investing to save Rs 1 crore for a goal which is 30-years away, the worth or the purchasing power of Rs 1 crore will be approximately Rs 23 lakh after 30-years.
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It means that even though you are earning a return on your savings, there is inflation that keeps eating into the returns. The net-effect is a corpus equal to Rs 1 crore but it’s worth at today’s cost is about Rs 23 lakh.
The other side of this is that if you are saving for Rs 1 crore, you will heavily fall short to meet the goal after 30 years. You will require nearly Rs 4.32 crore after 30 years to meet the goal that today costs Rs 1 crore.
Now that you have seen the impact of inflation on your savings, make sure you start investing after factoring in inflation.
If your goal at today’s cost is Rs 25 lakh and you want to meet that goal after 10 years, here’s the excel sheet formula to calculate the reduced amount ( worth) after 10 years, assuming an annual inflation of 5 per cent.
Reduced amount = amount/(1 + inflation rate)^number years
= 2500000 / (1+.05)^10
= Rs 15.34 lakh
So, instead you need to save for a higher amount after adjusting for inflation. The formula to calculate the required amount is:
Required amount = amount * (1 + inflation rate)^number years
= 2500000 * (1+.05)^10
= Rs 40.72 lakh
In order to offset the impact of inflation and maintain the same worth, you need to save for the inflated cost and not at today’s cost. Therefore, instead of saving for Rs 25 lakh, you have to save for Rs 40.72 lakh to meet the goal comfortably after 10 years.
