Investing only in fixed deposits that are taxed at the highest bracket can prove costly
At the close of 2020, when the economy shrunk due to the Covid-19 pandemic, inflation in India was deemed at an alarming 4.6 per cent. It went past the 5 per cent mark in February. We all know what this sentence means, don’t we? From a macroeconomic perspective, rising inflation and its impacts are well spoken about and understood. However, the way this situation affects each individual and their personal finances is quite different. This is where the concept of ‘personal inflation’ comes in.
Simply stated, personal inflation is nothing but taking the estimated macro inflation rate and applying it to your own personal expenses and financial goals. To put it in quantifiable terms, you can assume this to be the rate of your total expenditure (everything from food to fuel including necessities and savings) in a particular year, compared to the expenditure you incurred in the previous year.
In 2020 your annual ‘all inclusive’ expenditure was Rs100, 000, 00
In 2021, this went up to Rs 1,05,000
Thus your personal inflation rate is 5 per cent.
From a financial planning perspective, this is a very interesting metric to ensure that your lifestyle, expenses and savings are aligning with the current economic environment that you are thriving in.
But how does inflation affect my finances?
While ‘inflation’ doesn’t affect your personal finances immediately, a sense of personal inflation greatly helps in maintaining a regular check on expenditure and preparing for the future.
Rohit, a small scale businessman in Mumbai has the following monthly expenses:
Fuel charges (electricity, gas, petrol)
Naturally, when the country is in a state of inflation, the prices of essential commodities like food grains, raw materials, labour, wages, goods and services rise correspondingly. These increased prices are thus invariably transferred to the end consumer, consequently inflating the final price and disrupting the monthly budget.
In Rohit’s case, an inflation of 4.6 per cent has thus resulted in a price rise in fuel and food. As an individual Rohit also indulges in a fixed number of monthly entertainment activities and a few leisure trips here and there. In this scenario, there is a high possibility that Rohit’s personal inflation rate may be much higher than the macro-economic rate estimated by economists.
Therefore, now to ensure that his financial goals remain unscathed by any sudden increase in prices of essential commodities – Rohit will need to realign his portfolio to suit the changing environment.
Here, he can take two approaches:
Prepare in advance:
Rohit can rely on information available in the public domain to understand what the historic rate of inflation (category wise) is and apply it to his own monthly budget. With a little research and planning, he will be able to ascertain an estimated price rise in his monthly expenditure and take corrective steps immediately. Thus, hedging himself before the risk arises.
2. Analyze and rejig your portfolio:
While the first approach was research based, this one is a little more analytical. Here, Rohit should look at investing in options that will help him beat inflation in the long term. Investing only in fixed deposits that are taxed at the highest bracket can prove costly. Instead, other investment options like Debt Mutual Funds, Equity and more tax efficient options will not only help Rohit beat inflation but also increase the value of his returns.
In the larger scheme of things, personal inflation rate depends on a lot of subjective and objective individual factors that the macro inflation rate does not take into account. The principle of one size fits all cannot be applied here anymore. Hence, to ensure that you receive that maximum returns out of the money invested, it is always prudent to understand your personal inflation rate and make tailor made decisions accordingly. You can also commission an expert financial advisor for yourself who will help you create a customised financial plan as per this personal inflation rate.
The author is Head-Wealth Management, Tata Capital Financial Services.
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