Inflation Rate for Retirement Planning - All You Need to Know in Detail

Every individual, whether he is a salaried employee or a business owner or a professional, has to plan for life after retirement. Although retirement may seem a long way off, the cost of all essential commodities and services (food, clothing, house rent, medicines, education, etc.) magnifies with each passing year.But what causes this increase and how does it impact one’s retirement plans? Let us explore.

Inflation is the phenomenon that causes an increase in the price of goods and services in an economy over a period of time. Inflation risk is thus rightfully known as purchasing power risk. To understand inflation better, let us consider an example:Aneesha has invested her savings in bank fixed deposits that generate a monthly interest of twenty thousand rupees. This sum is adequate to cover the cost of her household expenses.Now, suppose if the inflation rate rises by 10% (meaning that there is a general rise in the prices of commodities by 10%), then the sum of twenty thousand will no longer be sufficient to cover the cost of Aneesha’s monthly provisions. She would need an additional 10% or two thousand rupees to compensate for the shortfall caused by the decline in her purchasing power.Aneesha would either have to manage her budget at a lower level or reallocate her investments to earn higher cash flows. Her investments, though tied up in safe bank deposits, are still exposed to the risk of inflation.

The cost of inflation poses an ever-looming threat to one’s retirement plans . Retirement budgets are ideally created well in advance. Future costs are estimated, contingencies are factored in, and a rough amount required to meet periodic expenses is ranged in.However, this amount represents nominal and not real values of the prices of commodities. This means that the budgeted figure only the present cost of demands and not their future expected costs. Basically, inflation brings down a person’s buying power.Even investments made to create a corpus for life after retirement have a long-term horizon. Here, inflation represents the risk that the amount received on investment may be worth less, when adjusted for inflation. Investors should determine if their investment returns are beating the cost of inflation.

Inflation risk is highest in fixed return instruments such as bonds, deposits and debentures. Thus, inflation has a particularly adverse impact on retired persons, whose income flows tend to be fixed in absolute terms. Investors must tactically allocate their money in channels that will help generate higher returns. Conservative investors must consider balancing their portfolio by investing in inflation-hedging asset classes like equities or commodities. In Conclusion Inflation is thus an inevitable threat to one’s financial plans. But if the effects of inflation are kept in mind since the very beginning, future retirees can start taking actions today to curb their risks. The bottom line is to create a realistic retirement budget and make investments that will help soften the impact of inflation.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.