Inflation & Financial Plans

Today there are many factors that may have an impact on your investment decision. Factors like government regulations, interest rates, volatile stock market, an event in overseas market, inflation etc . today impacts your financial planning activity like none. They have become too important to be ignored in your financial planning exercise—especially inflation. 

If ignored, inflation can hurt your standard of living. If your income increases at a rate less than inflation, your standard of living declines even if you are making more money. Simply put, inflation means paying more for same set of services.

While evaluating a financial product, we should evaluate the expected real rate of return. For example if a financial product offers 10% pre-tax return in a year, and if inflation is 5%, then real pre-tax return is 5%.

More often than not, inflation is rarely factored in by investors while investing.  Coupon rate is more often than not the sole guiding factor. This is true even for urban investor. There is low level of financial literacy among urban consumers. Investors usually do not consider external factors impacting their financial decisions (inflation being one of them) and the options as regards choice of products to mitigate the risks inherent in the financial product. A classic case in the point is less appreciation for term plans offered by insurance companies. Though it is the best form of pure insurance, people still look for endowment plans and ULIPS forgetting the fact that insurance is not meant to generate return, but manage risks. Though there is a better awareness about different financial products available amongst urban investors, it’s suitability to one’s financial needs is lacking. They fare poorly when it comes to deciding where, when and how they need to allocate their savings. This brings us to the most important factors of a financial plan:-

Identify your goals and quantify them

Rather than saying that you need X amount of money after n number of years, it is better to say that “I need Rs. 20 lacs for my daughter’s education 20 years hence. It’s like boarding a train before ascertaining your destination (goals). Clarification about the target corpus after a definite time frame will make your asset allocation more aligned to your goals. Even this 20 lacs figure has to be arrived at taking into account the inflation. Rs. 20 lacs in today’s term or after 20 years.  Let’s take an example. Say your current age is 27 years and you plan to retire at 65. Your current annual expenses are Rs. 300,000. This means that you need to accumulate a corpus of about Rs. 1.90 crores just to maintain your present lifestyle. (Assuming you live till the age of 85 years and the inflation rate is 4%). In order to accumulate this corpus, you need to invest Rs. 6450 per month religiously for next 38 years in a retirement plan that offers 8% pa.

  

Now earning is just one side of the coin. Your earnings need to be secured also, so that in case of a misfortune, your family’s needs can be taken care of. Let’s consider the case of a healthy 25 year old person with an annual income of Rs. 100000/- pa. Let’s also assume that while his income increases at the rate of 10% annually, inflation is at 4%. At 50 years of age his real income will be Rs. 10 lacs pa... However, in case of his unfortunate death at say 42 years of age, the loss of income to his family would be nearly Rs. 500000 per annum. Hence, if he is buying a protection plan—which he should be anyway—he must aim for a cover of Rs.10 lacs.

Revisit your goals and plans regularly

Once you have zeroed in on a financial plan, it is necessary that you re-visit it, evaluate and realign it periodically. If you have invested in an equity product, then you should switch out to a debt fund as your retirement approaches near. This will not only ensure safety of your corpus, but also ensure regular cash flows.

Financial plans must be revisited and re-evaluated in line with the macro situation and life stage.

A visit to a certified financial planner can prove to be useful, after all managing money requires more skill than making it. A certified financial planner can offer proper unbiased guidance in these situations.