is 21 years old. You estimate the present cost of such education to be Rs. 20 lakhs. How much corpus should you accumulate at the end of 11 years to be able to fund your daughter’s education? Assuming an annual inflation of 7% per annum, you must have Rs. 42 lakhs when your daughter is 21 years old, to be able to meet her education expenses. Increase this inflation to 9%, and this amount shoots up to Rs. 51.6 lakhs. This is the effect inflation has on education expenses.
So as it can be seen in the above examples, inflation plays an extremely important part when you plan your finances. Although it is impossible to determine exactly how inflation will be in future, looking at past trends and the current economic scenario will help you to estimate this approximately.
This brings us to the next important area of what should be your choice of investments, keeping in mind the inflationary trends. You must invest in instruments which give you higher post-tax returns compared to the inflation rate.
Let’s say you have Rs. 50,000 and wish you invest this for 15 years. Now, if an annual inflation rate of 10% is assumed, you will need Rs. 2.08 lakhs to maintain the same purchasing power for your Rs. 50,000. Let’s look at the following three cases:
Case 1: You invest Rs. 50,000 in a fixed deposit for 15 years, which gives you a post-tax return of 8% per annum. The total amount accumulated at the end of 15 years is Rs. 1.59 lakhs.
Case 2: You invest Rs. 50,000 in equity mutual funds for 15 years, which gives you a post-tax return of 14% per annum. The total amount accumulated at the end of 15 years is Rs. 3.57 lakhs.
Case 3: You leave this Rs. 50,000 un-invested in your savings bank account, which earns 4% interest annually, for 15 years. You will have Rs. 90,047 at the end of 15 years.
As you can see, in Case 1 and Case 3, the amount earned in much lesser than what is needed to maintain your purchasing power, ie: Rs. 2.08 lakhs. Even an investment yielding 8% post-tax return does not look attractive, simply because of the exceptionally high inflation rate of 10% per annum, which has eaten into the value of your money. So you must earn a return of at least 10% per annum, post-tax, to