It was 2002 and I was in the final year of engineering in one of the NITs. Back then, the fee per semester was 6,000 and that too including the hostel stay. Recently, I checked how much fees NITs are charging nowadays. The fee structure varies from 66,000 to 1 Lakh per semester. I am not sure whether the hostel fee is included in the same or not. As you can see, there has been an increase of around 60,000 in 17 years. Yes, 60,000 may not seem to hold much value in today`s time. But going from 6,000 to 60,000, it is undoubtedly a steep hike. Moreover, that is how we go about calculating inflation.
Do you realize how much is the inflation percentage in the above-mentioned example? It is 15%. Furthermore, education in these NITs is still highly subsidized. You can imagine what the scenario would have been like if it was not subsidized in the first place.
Coming back to how inflation impact your financial goals. We will discuss the return part in the latter part of the article.
Let me first define the major financial goals of an individual in normal circumstances.
- Child Education
- Retirement goal
Now, let us take an example of a person named Suresh. He wants to provide 20 Lakhs for his son’s education and 10 Lakhs for marriage. The wife of Suresh is 3 years younger than him. Moreover, Suresh wants to provide 50,000 per month for his retirement expenses as per today’s cost trends.
Presently, Suresh`s age is 35 years and he is planning for his retirement at age 60. Since his son is only 2 years old, he wants to provide the required amount for higher education after 15 years.
As already mentioned, Suresh wants to provide 20 Lakhs in today`s cost for the higher education of his son. The value of 20 Lakhs after a period of 15 years would be 63 Lakhs, assuming 8% inflation.
What if Suresh has not invested any amount till this point of time for his son`s higher education? In such a case, the amount required to reach 63 Lakhs in 15 years would be 17000 per month. (Assuming 9% returns)
What If Inflation Rate Is At 10%?
What if the inflation for education comes out to be 10% in a time span of 15 years? Assuming 10% inflation, the value of 20 Lakhs after 15 years would be 84 Lakhs.
Now, that is a big difference of 21 Lakhs.
The investment required would be 23,000 if Suresh wants to achieve 84 Lakhs in 15 years for his goals. That is an increment of 6,000 per month.
This scenario is very much feasible as most of the government institutes in India are still subsidized. The chances are that the normal inflation rate may remain at 6% while the education inflation rate may go over 10%.
I am assuming a debt-equity ratio of 50:50 for returns in the above-mentioned scenario. A conservative investor may have to invest a lot more since he/she is only interested in debt investments.
So, what if Suresh plans to invest only in debt instruments for the aforementioned goal? The investment required to achieve this amount of 63 Lakhs would be 22,000 per month. Whereas to achieve 84 Lakhs, the investment required would be 30,000 per month.
This is precisely the reason, why you should consider both inflation and returns while planning your financial goals. More importantly, it is also the reason why asset allocation is necessary.
Also Read: Asset Allocation by Age or Goals
As far as child education is concerned, we have had a detailed discussion on the inflation part. Now, let us talk about the returns over inflation. For the retirement goal, I will take 3 scenarios into consideration.
- Inflation during the accumulation period.
- Returns over inflation during the withdrawal period.
- Life expectancy
How much amount of money would be required if Suresh wants to retire at age 60? And that too with monthly expenses of 50,000 as per today’s cost trends?
Also Read: FIRE Retirement with Calculator
Assuming 6% inflation, the value of 50,000 would be 2.15 Lakhs at age 60. The corpus required would be around 6.2 Crores to manage the monthly expenses of 50,000.
I have assumed returns over inflation as 1% and a life expectancy of 85 years. (If inflation after retirement is 6%, the returns would be 7%.)
The investment required would be 59,000 per month assuming returns of 9%.
Now, let us play with a couple of figures here.
What If Inflation Rate Is At 7%?
What if the inflation rate is 7%, the corpus required would be 7.9 Crores at the time of retirement? There will be a difference of 1.7 Crores with a 1% increase in the inflation rate. (Assuming that other things remain the same, return over inflation – 1% and life expectancy is 85 Years.)
The investment required in this case would be 75,000 per month.
Also Read: Best Investment Options for Retired
What If The Return Over Inflation is 0%?
Everyone wants to be financially secure after retirement. Most of the people want to keep their entire corpus in debt instruments. It is perfectly fine to keep most of your portfolio in debt funds. Nonetheless, to beat the inflation, you need to have some portion in the equity portfolio as well.
Suppose you have kept your entire investments in debt instruments and you are getting a 0% return over inflation. How much corpus would be required in the above-mentioned example?
When we had taken return over inflation as 1%, the corpus required was 6.2 Crores. If the return over inflation is 0%, the corpus required would be 7.1 Crores. Again, a difference of 90 Lakhs.
What if life expectancy increases from age 85 to 90? How big of a difference will it make?
Can you try to imagine? Again, the difference would be 90 Lakhs as the corpus required is 7.1 Crores.
This article is not to frighten or scare you in any way. Its purpose is to make you think of the scenarios which might pop up in the near future. You may have the time to invest more at this moment. But would you be able to do the same after your retirement? Would you be able to invest more when the higher education goal is approaching near? Moreover, even the amount would be substantially high to invest.
Give it a thought and keep investing!