Impact of inflation and taxes on investment return?

Now a days inflation is big worry for all of us. We often read and hear about it from media. Controlling inflation  is a big challenge for current Indian government . Both government and Reserve bank of India has put all the efforts to control it. So for general investor how important is it. In this article we are trying to analyze impact of inflation on investment return.  Everyone knows that inflation eats into savings and increases costs. So it is important to invest wisely for to maintain your current standard of living with increasing inflation.

Whenever you consider an investment option, remember to evaluate the expected rate of return in real terms. The real rate of return means deduct your expected compound annual rate of inflation for the investment period from the compound annual rate of return that you expect from your investment.
To understand it more clear we are taking one example here say you are considering a bank fixed deposit that promises you an 11% annual rate of return over the next five years and your expectation of inflation during this period is 7% (compound annual).

For this investment, your real compound annual rate of return is only 4%. If your income from this investment attracts a 30% tax rate, then your post-tax real rate of return further reduce to 0.7% only. This 0.7% is very shocking figure in compare with 11% that you might be using to evaluate this investment option. So inflation and taxes play vital role to fix the real rate of return.

On a 10-year investment point of view if Rs10,000 invested today in bank deposits (yielding 0.4% post-tax, real rate of return) it would be worth Rs10,722 whereas the same amount invested in an income mutual fund is likely to be 38% higher at Rs14,802. Presumably, this should compensate you for the slightly higher risk to which your investment is exposed. (To understand more about the impact of compounding returns on investments

The above example  that inflation and taxes are important factors to consider while evaluating investment returns and how a little more attention to your investment decisions can result in a significant improvement in your financial health. To understand the approach and benefits of financial planning more....keep reading my blog. I will put my best effort to bring more useful  information  about investment and financial planning.

Regards,

Arvind Trivedi