Why CPI is not a true indicator of actual Inflation • RoboAdviso | Best Blog for Mutual Fund and Investment in India

Why CPI is not a true indicator of actual Inflation

Roboadviso     Asset Allocation,Economy,Financial Planning     Posted On, Mon 22nd August, 2016     No comments

real inflation India mutual fund
Last month (July, 2016), inflation rose by 6.7 percent as a reflection on high food prices. Financial analysts do not expect the price rise to come down anytime in future. In theory, this rate may not really appear as a cause for concern. However, one should note that this percentage is applicable for a varied set of population, most of which are in low middle class. The middle class and upper-middle class are slapped with much higher inflation than what the index indicates. Also, we had shown in our earlier posts, that inflation in housing, education and health sector is much higher than the consumer inflation.

The CPI is not a customized indicator of price rise
The CPI (Consumer Price Index) does not give a true picture of the actual expenses of an average middle-class family living in a town or city. In that index, the increase in education in the past year has been quoted as 4.31 percent while most fees in schools and other miscellaneous expenses show a yearly rise of 9 percent. High education rises at the rate of 10 to 12 percent each year.

If a parent only looks at 6 to 8 percent as the rate of inflation and plans for his child’s education, then he may end up having a corpus that is much lesser than what is required in future. Let’s assume higher education course costs Rs.9 lakh today and according to a 7 percent trajectory, he targets Rs. 24 lakh for his daughter’s education in 15 years. But instead of 7 percent, if the fees rise by 10 percent, he will need almost Rs. 43 lakh, double of what he was targeting.

Assuming a high inflationary rate is erring on the right side of caution; it is better to be safe than sorry later. Ideally, most financial experts like to keep an inflationary growth of 10 to 12 percent for education and 12 to 14 percent for health.

Another important thing to note is that with rising income, we opt for a better lifestyle. Lifestyle inflation is an inherent part of our spending pattern. Today, most people eat out at fine-dining restaurants on a frequent basis then they did 10 years ago. As costs go down, consumers have more options and when they have more options, they are ready to spend more. For instance, with call rates going down, mobile phones are now a necessity than a luxury. You may be spending less per call but you are paying more for the privilege and tons of value-additions.

Instruments that beat inflation
Once you are attuned to a certain lifestyle, it is not easy to get rid of it. However, you can take a review of your spending patterns and cut down on needless spending. Most importantly, you have to invest in the right inflation-beating instruments, so that you are able to have enough corpus for long-term goals like your children’s education, a huge palatial house, retirement or whatever catches your fancy.

The average urban CPI in the past 10 years has been 8.07 percent. Cash stashed in your locker will give you 0 percent returns, money in savings bank account will give you 4 percent returns, fixed deposits give you 5 to 7.5 percent, insurance policies (despite all their promises) give you just 6 to 7 percent returns, gold offers you anywhere between 6 to 7.5 percent and PPF gives you 8.1 percent returns. Thus, we see that all these instruments give returns well below the compounded inflation rate.

Here are investment instruments that beat inflation –
• MIP (Monthly Income Plans) – 7 to 9 percent
• ULIPS – 8 to 12 percent (depending on the asset-mix)
• Balanced Funds – 10- 12 percent
• Equity mutual funds – 12 to 15 percent.

No doubt, equity mutual funds are the way to go, if you want to accumulate inflation-proof returns. With no capital gains tax to pay if you hold on to equity mutual funds and balanced funds for more than 1 year, they offer tax advantages like no other.

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