Inflation & Return on Assets

Inflation & Tax both are the silent money killers. Inflation will erode the purchasing power of your money over the time. Because of the inflation, the purchasing power of your money reduces over the time.

The problem with the inflation is that, you can’t see it. And that’s why most of the people believe that their money in Fixed deposits and government bonds are safe. But well, your money in fixed deposits and other fixed return instruments are not totally safe. Because the inflation eats up its purchasing power over the time.

The Real return on any asset is = Return offered by Asset – Inflation

So now, suppose GOI Bonds are giving you 8% annual return and the inflation is 5% per annum than your real return on the asset is (8-5) just 3%.

Now, let us talk about Deflation. Deflation means negative inflation. During the time of Deflation, it is better to become a lender (Bond Holder) rather than a borrower because the purchasing power of your money increases because of the deflation.

Right now, Indian Economy is in deflation. It means that, the current inflation in India is –1.5%. So Actual return on GOI Bonds is (8 – (-1.5)) = + 9.5%. That’s good.

During the time of Deflation, The negative inflation works on the Asset in favour of its owners and make them richer.

Thus, Inflation works on your Assets in negative direction. Your Assets work in favour of you to make you richer but the inflation works against your assets to reduce its over all real return. And that’s why before investing, one should carefully count the real return from the Asset…!!!