You must have heard the famous line “A Rupee today is Worth More than a Rupee Tomorrow”. But what does it really mean, what’s the science behind this statement?
Everyone is earning money, whether enough or not, this totally depends and differs from individual to individual in relation to their needs and desires. But what about you, are you able to earn abundant money to satisfy you needs? Talking about the general idea of financial planning which you may think at very first instance when it comes to increasing your wealth is to start “savings”. Saving money by putting the sum into savings account, creating FD’s or investing in order to get high return on our deposits. Obviously, this is a rational thinking but are we really growing our wealth? Or we are not aware of some facts and calculations, Let’s find out.
Delving into the current economic scenario, today we live in very uncertain times where jobs disappear without any prior intimation, currency fluctuations are constant and saving is no longer enough. At one point of time, you will realize that things cost more over time and doing nothing with the money when you have it will result in reduction of buying power. Moving towards understanding the logic behind the head line why money gradually loses its power basically what impacts the value of money.
The main culprit for this cause is INFLATION and interest, you must have heard these terms before but let’s have a clearer picture of these. INFLATION is the rate at which the cost of goods and services rises, which simply means the value of money depreciates thus resulting decrease in your buying power. Due to inflation a rupee today will not be able to buy the same value of goods tomorrow. I will explain this to you through a data table by demonstrating how the value of Rs 10,000 continuously decreases over longer period of time.
INFLATION PERCENTAGE PER ANNUM
So, you saw how over years, the value of money depreciates and you have to pay more in order to maintain same standard of living. But keeping in mind you have other expenses too like post retirement planning, education etc those will cost more too. Like doing an MBA today of Rs 20L will cost you around Rs 46L at 7% inflation after 15 years.
In order to meet that expense after 15 years, you will have to lock more than Rs 11L today in a fixed deposit at the rate of 9 percent. If you take into account taxation, this figure will even be higher, this is because you have to pay tax every year on your fixed deposit interest income and re-invest only the balance. And this is not enough in the long run, especially for salaried individuals.
Now, can we beat Inflation? Yes, we can beat it but not by putting our money into FD’s. To fight inflation, we need to do something that would give us more return than inflation and that is to “Invest in INVESTMENT” this would leave us in surplus to meet our target. If not, we will find that the value of our investment has reduced..Oops now? See what happens is for example you saw an investment with a return of 10% that’s great you will definitely invest in it for sure but do you really get that return? The answer is no and that’s what you need to know you have to factor in inflation to know actual earning.
That is called Actual Earning. REAL RETURN = Stated Return – Rate of Return.
In addition, if you take into account the tax implications, the real return might be even lower. Hence, assuming that the stated return is 10% at an inflation rate of 7%, converting into a real rate of 3%, a 30% tax on 10% interest income would drop out 3%, which is real return.
Real Return= Stated return – Inflation – tax rate
That doesn’t sound good. So, the next time you have money to invest-
· Invest in Investments that deliver a “Real Return”
· You might consider investments such as equites, real estate, mutual funds? which historically have given Real Return