POSTED BY October 12, 2010 9:34 pm COMMENTS (12)

ONWhat do you think will be the average inflation rate in India over the next 30 years (i.e. looking at the horizon of 2040)?

I’m just trying to calculate what amount of money I would need in retirement to maintain the same standard of living as currently. One would need to account for inflation when I calculate that.

Thanks,

Ram

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Shashank,

Each of your answers is becoming a “best answer”. I think it tells you of what I think.

Your matter is highly informative and very true. The part about being conservative is very true for me as well.

I don’t have an idea of the Steady State View, and I’m very much looking forward to your next post. Please do find some time for it.

Regards,

Ram.

Ram,

Thanks for your appreciation!

Before I write more on the ‘core assumptions’ for future projections or about the ‘steady state view’ , let me share an incident here. This story will illuminate the way I have thought of regarding the ‘core assumptions’

Some 5 years back I was discussing PPF investment with a client cum friend at his residence when I went there to make my call. This person was a GM level employee in a listed multinational engg company with work experience of @ 20 yrs. As we were talking about PPF investments he said to me that he already invests substantially in PPF and he has also worked out some calculations regarding the corpus he would be accumulating in next 15 years, till his retirement. He pulled out his laptop ( I don’t carry one on a call. My tools are a sheaf of plain papers and pen. I even teach my associates and clients as well how to attemt complex cash flow calculations with a very good degree of accuracy without calculators or Excel sheet!).

He showed me how he has gone about assuming interest rates on PPF a/c for future years. He said he has done it with a cautious or conservative attitude. For the coming next five years he had considered the intt rate to be 8% only. Then for the next 5 years he had taken it to be 6% and for the last five years taken it to be 4.5% only. And so much money would be accumulated at the age of his retirement in the PPF a/c! He was quite satisfied with the way he had made all these calculations with a conservative manner. And can you really find a fault with this logic of being conservative? No,rather we will say what a sensible and prudent guy such a person is, isn’t it? This is how everyone should attempt it rather than being unnecessarily optimistic about returns on our investments in future and relying on such optimistic figures to base our decisions of future goals, isn’t it?

Upon looking at all these calculations I asked him if he thinks about inflation then does he think that it will go down or move up? He replied it would definitely move up and that is how a conservative person should think or consider it to be. So I asked him then why he has considered that inflation is going to go down all these years in future and probably reaching a figure @3-3.5% in the years near to his retirement? He was confused for a moment. I said don’t you think the PPF scheme, a government run one, would try to link the returns to the general inflation level. Hasn’t it been the case in these last years when the rate was brought down from a high of 12% to the present level of 8%?

Suddenly he realised the folly of his assumptions; the arbitrary and sensible sounding, he had considered for future calculations and projections. Till then he was following a narrow and unilateral perspective about investment and returns! This mistake is done by a majority of not only lay persons but many of the financial planners also. The mistake of narrow perspective and unlinked thinking!( When I will show you this link which should be factored in even between the ‘financial capital’ and the ‘human capital’ for proper financial planning, you will think how could you neglect these fundamental principals and why no one told me these simple and important aspects of financial planning. But more on this ‘human capital’ sometime later!)

So what is the best way to assume? I said to my friend haven’t we been tought about a ‘steady state view’ of things in so many derivations and formulie and constant values , factors in so many subjects we have studied?

Ram, I’m again running short of time so in the next comment I will write about,

The Core Assumptions: The ‘steady state view’ and related set of assumtions-

1) Steady State View of things

2) The ‘self balancing mechanism’ in the portfolio

3) ‘Portfolio review’ and ‘career review’ i.e. the ‘financial’ and ‘human’ capital

How to use them for sensible projections and decision making about future accumulations and ‘goals’ achievement in personal financial planning.

( Your feedback is awaited as it will only motivate me to write more!)

Shashank.

Ram,

Your querry is interesting. You have asked it in the context of how to go about calculating the projections in future about expenses and the related goal values. This is a very tricky issue for a financial planner or anyone; what should be the basis of projections when such a long duration of 15/20/30 years is to be considered?

I will answer it in two parts. One concerns your curiosity about past inflation values i.e. historical performance trend value and how to calculate it. I usually tell this story to a client about calculating the general inflation rate (after I have educated him about the ‘rule of 72’.)

When I came to Pune to do my BE from COEP some 28 years back the ‘cutting chai’ used to cost 50 paisa. Today it costs @Rs 4/-. So a growth of @ 8 times in the cost of ‘cutting chai’ cup. This 8 times is 2*2*2 i.e. around three times the prices have doubled. So @ every 9.33 years it was doubling. So according to the ‘rule of 72’ calculations the interest rate or the growth rate has to be @8% for doubling in @9 yrs.

You will notice that the long term rate calculated from the exact historical data figures also is very close to these calculations.

Some two- three years back the cutting chai was Rs 3.i.e. 6 times cost increase in @25 years. So three doubling cycles not happening means the rate is @6.5-7%. Because of headline inflation rate going upto 16% and beyond it has pulled up the long term trend rate up to 8% now.

(The value of the ‘chai’ gives a fair picture about inflation between any two periods of time because it factors in the price of sugar, tea, milk and fuel. A fair representation of consumers’ general grocery bill expenditure.)

If you can master the ‘rule of 72’ and learn to use it for compounding /discounting; it is a very powerful tool to ‘see’ a picture or visualise the ‘landscape’ in financial planning and doing numerous calculations ven without touching the tools like calculators or excel sheets. It helps you to have the mental pictures or images of various scenarios very quickly.(More on it some other time)

Second thing you have mentioned is about attempting the future projections. This we usually attempt with only historical data basis. Like in caseof equities we will say that the future growth to be @15-16%. Why, because that is how the historical data i.e. the sensex has grown over past period of time. Or similarly for the debt returns would be put in a 8-10% bracket.

So how to attempt the future projections? What basis or assumptions to be made?

It should be done on the basis of ‘steady state view’ of the things. Means just consider future to unfold just like it has today.

(more on it in next comment)

Shashank,

Brilliant! Thanks for your reply. I’m eagerly awaiting your “next comment” that you talked about in this one.

Manish, thanks for selecting this answer as the Best Answer. I would have done it anyway :).

Thanks,

Ram.

From 1969 until 2010, the average inflation rate in India was 7.99 percent reaching an historical high of 34.68 percent in September of 1974 and a record low of -11.31 percent in May of 1976.

Hope it will help you.

InvestmentKit.com

@MoneySavingsHelp

Thanks! Great info. Where did you get this from? Is there a site where such data is freely available?

Source for my data:

http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=INR

InvestmentKit

Great. Thanks again!

Thank you all for your responses.

Would anyone know what the average inflation for the last 15/20/30 years was?

It’s difficult to predict for next 5 years, leave 40 years. Remember, the real inflation is MUCH higher than Govt. figures. The best way is to review your portfolio from time to time and adjust your investments accordingly.

Hope it will help you.

InvestmentKit.com

check out ths link for inflation rate

http://www.hdfcinsurance.com/Products/PensionPlans/PensionPlan.aspx

click on the retirment planner calculator

Dont think about the inflation now and get panic, enjoy your life with limited amount and rest as savings, maintain that savings in PPf or SIP, this would help you at your retirement stage….