Inflation impacts every part of the economy, including consumer spending, company investment, employment rates, government programs, tax policies, and interest rates.
Understanding inflation meaning is critical for everyone but especially investors because it has the potential to diminish the value of investment returns. With inflation recently climbing to its highest level in four decades after several years of relative quiet, investors may benefit from understanding the reasons driving inflation, the impact on their portfolios, and strategies to take as the investment landscape shifts.
What is Inflation?
Understanding how market forces can affect your assets is the first step in protecting yourself from potential negative consequences. Every year, the inflation monster drains away at your wealth! Many people who work hard to save money cannot adjust to inflation.
How do you prepare for it?
One reason many people don’t deposit all of their money in the bank is that inflation might diminish the value of those savings over time. As a result, some people prefer to keep some of their money in potentially higher-growth investments such as equities or mutual funds because these investments earn more per year than the inflation rate on average (although they also carry a risk of lower earnings or loss).
Types of Inflation
- Demand-pull inflation: Demand-pull inflation occurs when the economy grows faster than its long-run trend rate of expansion.
- Cost-push inflation: Rising energy and commodity costs could trigger cost-push inflation.
- Wage push inflation: Inflation is usually caused by rising wages. In effect, the rising wages raise costs for organizations, which are passed on to consumers through increased pricing.
- Imported inflation: This inflation is caused by the rising price of imports, e.g. due to devaluation. Imports will become more expensive when the exchange rate declines. As a result, prices will rise entirely due to the exchange rate effect.
- Hyper Inflation: This is reserved for extreme forms of inflation, usually greater than 1,000%, though no formal definition exists. Hyperinflation occurs when prices change so quickly that it becomes a regular occurrence, and the value of money falls rapidly.
- Core Inflation: The inflation rate eliminates ‘volatile’ temporary factors like energy and food prices.
Impact of inflation on investment
The impact of inflation on investments varies depending on the type of investment. Inflation can cause performance in assets with a fixed yearly return, such as conventional bonds or bank certificates of deposit because you obtain the same interest payment each year. For example, if you receive a $100 payout every year, it will be worth less and less each year due to inflation.
How can it impact your savings?
Inflation can lessen the value of your savings over time because prices usually rise in the future. It is self-evident when dealing with cash. If you keep $10,000 under your bed, that money may not be worth as much in 20 years. While you haven’t lost money, your net worth has decreased due to inflation eroding your purchasing power.
Inflation rate in India
Inflation in India has been high, and it is vital to plan for the same. In other words, inflation is the reverse of compound interest, like decompound interest. Although each year’s inflation is increased from the previous year’s inflation, the impact is similar to compound interest. Consider the following scenario: you invest Rs.1 lakh in a deposit that earns you 8% per year. At the same time, prices are rising significantly at an annual pace of 8%. In this case, your compounding returns will keep up with inflation.
The annual consumer price inflation in India accelerated to 6.52% in January of 2023, the highest in three months, compared to 5.72% in December, and above market forecasts of 5.9%.
How do you prepare for it?
One reason many people don’t deposit all of their money in the bank is that inflation might diminish the value of such savings over time. The effects of inflation can have an impact on people’s hard-earned money.
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