What is inflation, and why you MUST know about it

When I was 10 years old, a movie ticket cost approximately Rs. 50. A dinner with family cost about Rs. 500 and a dozen bananas cost Rs. 20.

Today, a movie in a similar theatre costs us Rs. 300. Dinner with family costs us upwards of Rs. 1,200 and bananas cost Rs. 50 a dozen.

And all of us have experienced this phenomenon.

This, exactly, is inflation. It is the increase in prices for goods and commodities over time. That happens due to various reasons which we will cover some other time. The point of this post is to explain what inflation is, and why you must know about it.

Inflation is defined by a rate. A percentage. The definition of inflation as per Wikipedia is “a general rise in the price level in an economy over a period of time”. So, if the inflation rate in India is 10%, this means that the general prices of goods will increase by 10% every year.

And that’s why I pay more for that movie, the dinner and those bananas today, compared to what I paid 20 years ago.

Now, here’s why you should know about inflation. Consider an investment scheme that gives you a 5% interest annually. This means if you have invested Rs. 100 today, you will get Rs. 105 after a year.

Now, if inflation in India is 6%, the products you are able to buy for Rs. 100 today, will cost Rs. 106 next year. However, your investment has only grown to Rs. 105. This means that if you are able to afford something today, you won’t be able to afford it after a year. Your buying capacity therefore has actually reduced. This essentially means that you invested in a bad scheme.

This is why you should know what inflation is. So that you can compare returns with inflation. In fact, it’s not even a comparison. It’s a hygiene factor. It’s basic. It’s what your investment scheme MUST give, among other things.

So, if your investment is not going to beat inflation over the given period of time, run away from that scheme!