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Friday, January 23, 2009

Inflation

Inflation-A Risk You Can't Escape

It's hard to take inflation seriously when you don't feel its effects today, tomorrow or even next year. If you ask me for Rs.100 and I can loan you only Rs.97, you could probably still make your purchase. It's only Rs.3 right?

Three percent inflation for one year is no big deal, but take a look at what 3% inflation does to Rs.100 over 25 years.

What Inflation does to Rs. 100/-

Case 1- Inflation rate 3%, value of Rs. 97 in first year. Second year onwards & beyond it starts decreasing to Rs. 64

Case 2- Inflation rate 5%, value of Rs. 97 in first year. Second year onwards & beyond it starts decreasing to Rs. 30

This is a hypothetical scenario using 3% and 5% inflation rates

Who needs to worry about inflation?

Inflation doesn't discriminate. Prices keep going up over time for all of us regardless of where we sit on the socio-economic scale.

Not much escapes the ravages of inflation. If you're lucky, your paycheck will keep pace with inflation. If you got a 3% raise in a year when inflation was 4%, however, your standard of living actually decreased by 1 %.

Inflation does the most damage to retirees and those living on a fixed income. Typically, they're more dependent on income from their investments than people still collecting a regular paycheck.

Some investments fare better than others

Your real rate of return on an investment is the amount left after inflation is subtracted. Real rates of return give you a more realistic idea of how much you'll actually have available to spend.

When you look at long-term returns for stocks, bonds and cash-equivalent investments after they re reduced by the inflation rate, you'll see that stocks did the best job of keeping ahead of inflation.

How to protect yourself from inflation

Consider the following strategies for inflation-proofing your portfolio:

  • Start investing as soon as you can to take advantage of the power of compounding.
  • Seriously consider investments with a track record of beating inflation.
  • Talk with your financial advisor about an investment plan tailored to your personal needs.

source: Franklin Templeton

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