Kolkata, December 9: When we think of scary monster with regards to personal finance, inflation takes the top spot. In simple terms, inflation means that the price of things go up with time. For this reason, Rs 100 will fetch a lot less in 10 years than it does today.
The idea of investing is to make money grow. Let us say that inflation is at 7 per cent. In that case if your invested money is growing at 7 per cent or less, Rs 100 will be less useful in 10 years than it is now.
Let us take an example to understand this. Suppose an engineering degree costs Rs 10 lakh now and you are investing for the higher education of your child who is 8 years old.
There are 10 years left till she becomes 18 and needs the money for her studies. When planning for her higher education, first your financial planner will estimate how much an engineering degree will cost in 10 years. Education inflation and medical inflation is generally higher than normal inflation. However, even if one takes inflation at 7 per cent, the engineering degree will cost Rs 27,59,032, 10 years later. Let us take a round figure of Rs 27 lakh. So when saving for your child’s education you will need to save Rs 27 lakh over a 10-year period.
Let us look at two investing scenarios now. In the first scenario you are investing in FDs that will give you an average return of 8 per cent per annum. In the second scenario you are investing in equity mutual funds that gives you an average returns of 12 per cent per annum.
The returns from FDs just about beat inflation whereas the returns from equities beat inflation by quite a margin. In the first instance you have to save Rs 14,758 every month. When you invest in equity, you have to save Rs 11,737 every month to reach the same goal.
If you invest Rs 11,737 every month in an instrument that gives you return of 8 per cent, your investment will be worth around Rs 21.5 lakh in 10 years. That will be a shortfall of more than Rs 5 lakh.
This is just one example. For bigger goals like building a retirement corpus, the impact of not saving in equity will be much more significant.
Let us say that you are 25 years old and your current expenses are Rs 50,000 a month. If we consider inflation at 7 per cent, and your life expectancy to be 80 years, you will need to have a retirement corpus of Rs 6.15 crore when you retire.
If you put your money in debt instruments which give you returns at 8 per cent, you have to save Rs 26,638 every month to meet your goal. However, if you invest in equity mutual funds that give you 12 per cent returns, you would need to save Rs 9,470 every month.
Since our income is limited and one needs to save for several goals, investing in equity is the only way to beat inflation and meet your financial goals. Of course, the investment needs to be done on the basis of asset allocation which depends on your risk appetite and other factors. However, do review your financial plan today to find out if you are investing enough in equity. It is never too late to make a course correction.