Inflation refers to the rate at which prices of goods/services increase during a given period, which could affect cost of living in a country. Increase in inflation could reduce our purchasing power and discourage us from making investments and create savings. Thus, maintaining steady rates of inflation in a country becomes crucial.
The supply and demand of money plays a pivotal role in maintaining inflation rates. High inflation comes about when the monetary policy is relaxed. If prices of goods and services increase, purchasing power falls and the value of currency diminishes. If the supply of goods and services is affected in the market, it can disrupt production costs. This can further lead to a sharp rise in food and fuel costs, which are traded across countries.
However, on the other hand, excess demand for goods and services can affect the economy’s production capacity, which might hurt value of resources. Hence, it is important that policymakers draft appropriate measures to find the right balance between demand and supply to maintain inflation.
Central bankers are responsible for holding the economy together by maintaining stable inflation rates. To impose monetary discipline in the country is extremely difficult. However, policymakers have the power to influence the country by sustaining inflation rates that best suit the economy. If there is instability in prices, policymakers usually influence demand by raising or lowering interest rates. When global circumstances drive inflation, bankers try to usually tame it by influencing exchange rates of the economy.
Cost of living generally depends on prices of goods and services that fit a family budget. A price change for a single good or service does not determine inflation. To measure overall inflation, the price change of a large basket of representative goods and services is taken into consideration. The combined price is the sum of the weighted prices of items in the basket. A weighted price is calculated by multiplying the unit price of an item by the number of that items the average consumer purchases.
It is important that investors should take into account the inflation factor while making investments. Generally, people ignore this very important aspect and make lower pre-tax returns because they have not factored in inflation into their returns. For example, if an investment offers 10% pre-tax return in a year and current inflation is 5%, the real pre-tax return on investment is approximately 4.8%.
However, this should worry you unduly or create apprehensions about investment. You should know that there are many tools to beat inflation risks. For instance, you can beat inflation by spreading the risks across securities or asset classes. Further, plans such as SIPs factor in inflation and offer you the returns you are looking for. SIPs are an excellent investment option. You can invest small amounts on a monthly basis in SIPs and enjoy steady returns. To understand more about how to factor in inflation into your investment plans and about SIPs, contact your investment expert.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.