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Impact of Inflation: How does it affect your savings

April 21, 2023

Table of Contents

    Table of Contents

      Discover the reason behind how keeping your money in the savings account is making you poorer and what alternatives you have.

      Getting your monthly paycheck is one of the best feelings in the world, isn’t it? But is it enough and safe from the impact of inflation? Should you think about it?

      In our lifetimes, we spend 40-50 hours a week working hard for 30-40 years for something as basic as a salary that allows us to become financially self-sufficient.

      Gotta make a living. We put that money in our savings account so that we have readily available cash whenever we need it.

      Savings accounts pay around 2 to 4% annually. That may not be the best return on investment, but it's certainly better than nothing. 

      How is a Savings Account making us Poor, then?

      The answer is Inflation. 

      India, unfortunately, has one of the world's highest rates of inflation but don't worry you can beat inflation, check out these 3 simple steps here.

      Everyone is concerned about inflation, as the costs of even basic necessities continue to rise year after year.

      In today's market, inflation is currently at or over 6%. It is substantially higher in metro areas.

      This means that money in a bank account, which is not growing, steadily depletes your wealth.

      If you do some maths, you’ll realise that over the course of 10-15 years, your purchasing power will be eroded by close to 20%-30%.

      And if we look back, inflation rates have virtually always been higher than what people earn in their bank accounts.

      So because costs are rising faster than your savings, the money you have in your savings account will steadily lose value over time.

      To combat this and grow your money at par with inflation, invest it. 

      You must have noticed yourself, that over the years - 

      • Your grocery costs have risen.
      • The cost of your fruits and vegetables has risen.
      • The rent on your home has gone up.
      • Your medical expenses have risen.
      • The price of your movie ticket has increased.
      • Your bill at the restaurant has gone up.
      • Almost all goods and services have grown in price.

      Let's start with a small example:

      Savings account interest rates are 3.5% on an average, whereas inflation in India averages 4.5%. 

      So if you put ₹100 in a savings account and get 3.5% annual interest, your investment will be worth ₹103.5 after a year.

      But things that used to cost ₹100 a year ago are now worth ₹104.5. Gradually, over the years, this gap will only get wider.

      It means that even if you put money in a savings account and earn 3.5% interest, you'll need an extra ₹1 to buy the same goods and services you could acquire for ₹100 a year ago.

      Here’s another example to understand inflation better:

      Parnika, Shreya, and Muskan are three buddies. In the year 2020, each of them gets ₹5 lakh.

      This money is necessary in the event of an emergency, especially during the pandemic. They each take a different strategy.

      • Parnika enjoys working with cash. She stashes the money in her savings account.
      • Shreya is unaware of any alternatives for building an emergency fund. As a result, she saves it in her bank account as well.
      • Muskan is aware of the advantages of liquid funds and invests her money in one.

      In the next 20 years, what will the investment worth be?

      • Every year, the true worth of Parnika’s investment decreases. The ₹5 lakh stored in the bank account after 20 years will be worth only ₹2.07 lakh. That's a greater than 50% drop in value. This is the most dreadful category.
      • In 20 years, the real value of Shreya’s investment would drop from ₹5 lakh to ₹4.12 lakh. That's not good.
      • Muskan’s investment would go from ₹5 lakh to ₹8.32 lakh in actual terms. That's more than double the amount she had in her savings account.

      Apart from inflation, there are few other figures to keep in mind, as per the latest data from the Open Government Data Platform

      • Any interest above ₹10,000 is added to your income and is taxed at the prevailing income tax rate. If you earn between rupees 5 - 10 LPA, that’s 20% income interest on your savings income. Taking 20% off a paltry 3.5 - 4% savings interest leaves one with 2.8 - 3.2%, ensuring you invariably make a loss.
      • Even if you fall under the 2.5 - 5 LPA income slab, effective gains after taxes would be between 2.8 - 3.8%, depending on your final income after adding savings interest. 

      Is there Another Option than a Savings Account where you can Keep your Money?

      Yes, once you have the bare minimum in your savings account, you have quite a few options in hand where you can put your money.

      You should make the most of the remaining funds by investing wisely. There are a variety of investment choices available, which will:

      • Give you better interest rates
      • Assist you in reducing your tax bill 
      • Assist you in increasing your net worth

      Your income and expenditures determine where, when, and how much you invest. Here are a few ideas for putting some of your savings to good use:

      1. Investing in Gold

      Gold is a valuable asset that has consistently increased in value, making it a safe and secure investment.

      Gold has delivered more than 20% YOY return over the last five years. It is thought to be a good diversifier that helps to lower portfolio risk.

      According to investment experts, gold investments should account for 5% to 10% of a person's net investment portfolio.  

      Now as the entire world goes digital, Digital Gold is becoming more and more popular.

      What is Digital Gold, you ask? It is simply an alternative to physical gold.

      It is free from exchange rate manipulations and variations and allows the investor to easily trade throughout the world without actually touching physical gold.

      2. Investing in Bonds

      A bond, like an IOU, is a debt security. Borrowers sell bonds to investors who are prepared to lend them money for a set period of time.

      When it comes to avoiding risks, bonds are frequently the best alternative.

      When you purchase a bond, you are lending money to the issuer, which could be a company, a municipality, or a government.

      In exchange, the issuer promises to pay you a defined rate of interest for the duration of the bond's existence, as well as to refund the bond's principal, also known as the face value or par value when it matures, after a set period of time.

      You'll get your principal back plus the interest you've earned throughout the course of the investment.

      Bonds also have a superior track record when it comes to short and medium-term investments.

      3. Investing in Certificate of Deposit

      A certificate of deposit (CD) is a type of savings account offered by commercial banks that restricts your access to the money you invest while paying significantly greater interest rates than conventional savings accounts.

      The deposit grows in value over time, but if removed before the end of that term, it may be subject to fees.

      This can be anything from a week to a year. A minimum investment of ₹1L is required. The Reserve Bank of India (RBI) is in charge of regulating this.

      4. Investing in Mutual funds

      A mutual fund is a corporation that collects money from multiple investors and invests it in stocks, bonds, and short-term loans.

      The portfolio of a mutual fund is made up of all of the fund's holdings. Mutual funds are purchased by investors.

      Each share represents an investor's portion of the fund's ownership and revenue. 

      Investing gradually using a systematic investment plan (SIP) in Mutual Funds can be a fantastic method to reduce volatility while gradually establishing an equity portfolio.

      SIP investments should be made in diversified mutual funds.

      5. Investing in Index Funds

      It's easy to be intimidated by the stock market, so start small. Index funds are a great option in such a case.

      Picking successful stocks is extremely difficult, even for experienced stock pickers, so why bother?

      An index fund, on the other hand, buys almost all of the largest equities currently trading on the stock market, in roughly equal amounts.

      An index fund allows you to diversify your portfolio by investing in a big number of stocks (200-500).

      Naturally, some will rise while others will fall, but historically, the former has outnumbered the latter.

      This is a far more straightforward and cost-effective investment method.

      6. Stocks

      A stock is a sort of investment that reflects a portion of a company's ownership.

      Stocks are purchased by investors who believe they will increase in value over time.

      When you buy a share of a firm's stock, you're buying a small piece of that company.

      Investors buy stocks in firms they believe will appreciate in value. If this occurs, the value of the company's stock rises as well.

      After that, the stock can be sold for a profit. 

      The main reason why investors choose stocks over other investment options is because stocks offer larger returns.

      Investing in Indian stock markets is safe; nevertheless, like with any investment, thorough study and planning are required.


      Remember - invest first, spend later, save last. Most people spend first and invest later when they receive a salary check.

      A better strategy would be to put money into savings first (say, 25% of your paycheck) and then spend the rest.

      The key here is discipline and consistency. If in doubt, hire a financial counsellor.

      The bottom line is that money should not be kept in a savings account or your house. Invest it in a liquid fund at all times.