Don't invest less only because inflation is low

Financial advisors factor in the long-term average rate to ensure savings not impacted

Consumer Price Index (CPI)-based inflation was down to a record low of 1.5 per cent in June, from 2.2 per cent the previous month. CPI measures changes in the price level of the basket of consumer goods and services purchased by households. The Reserve Bank of India expects retail inflation to be 2-3.5 per cent in the first half of 2017-18 and 3.5-4.5 per cent in the second half of the financial year.

However, your financial planner continues to assume inflation at 7-8 per cent while making your financial plan and fixes a certain amount for you to save each month to meet goals such as children’s education or retirement. Wouldn’t you like it if your planner used lower inflation numbers and asked you to save less, thereby leaving more money in your hands for spending? However, that might not be such a good idea. 

To clients who enquire about the current low inflation figures, Deepali Sen, founder, Srujan Financial Advisers, explains that the figure assumed in her calculations is a long-term average for 10-20 years. “Financial planners wait for a trend to form before making strategic changes. Based on the current rate of inflation the amount of money required to build the corpus will go down drastically, which would mean surplus in the client’s hands to spend. But what if inflation rises again to 5-6 per cent? If you fall short on your corpus, that will hurt you,” she says.

If you look at inflation data over the past 20 years, on an annual basis, CPI has ranged from 12.4 per cent in 2009-10 to 3.4 per cent in 1999-2000. The average works out to 7.5 per cent. 

Moreover, within the household spending basket, the cost of many things does not fall even when inflation trends lower. These include magazines, periodicals and cable TV bill, whose costs remain fairly static. Prices tend to fluctuate in case of items like provisions, eating out, etc. “Due to this, the overall change in household budget is moderate and does not call for any change in strategy,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories. 

Besides, low inflation typically goes hand in hand with lower returns. “Interest rates on fixed-income instruments have not yet declined as sharply as the dip in inflation. But this will correct within a couple of quarters,” says Sen. Adds Sadagopan: “There will be a positive impact of inflation on the expenditure front. So we can potentially assume higher surplus. Put any surplus into a liquid or a short-term fund, so that it can act as a buffer over the long term and make up for any fall in returns from investments.”

Both while using investment return and inflation figures, financial planners rely on long-term averages. “Just as financial planners will not use more than 10-12 per cent returns from equity investments, even though currently returns are at 20 per cent plus, similarly calculation for inflation too does not change,” points out Manikaran Singal, founder, Good Moneying Financial Solutions.

For expenses like education, financial planners assume inflation at 10 per cent. Similarly, in case of insurance, the increase in premium cost is assumed at 8 per cent. One also has to factor in lifestyle inflation. For example, if you plan to go on a foreign trip next year, you have to factor in higher expenses for hotel and food expenses, even if the prices of air tickets decline.