Recently my mother received Rs 2 lakhs from a money-back-insurance-scheme on its maturity. She had been paying a small amount every year for the last 15 years. Now, 15 years back when the insurance agent told her that she would be getting Rs 2 lakhs she was excited as it looked like a large amount back then..
Unfortunately, today when she actually received her amount, the reality is a lot less rosy than she had imagined back then. She had grossly underestimated the eroding power of inflation on money.
Now most of us, similar to my mother may end up underestimating our future requirements, as inflation increases all our costs gradually and most of us tend to not appreciate its significant impact over the long run.
How do we ensure that this doesn’t happen to us?
She can obviously use an excel and calculate her future requirement by plugging in some inflation and current cost estimates. But knowing my mother’s aversion to excel and numbers, I wanted to give her an easy way to approximate her future costs.
So here is an easy shortcut..
Historically, India has witnessed an inflation of around 7-7.5% (refer here)
(While inflation has come down recently, I would still like to be conservative and go with history 🙂 )
Short cut 1: Estimating future cost
As it is tough to calculate the compounding formula ( future cost = today’s cost*(1+inflation)^no of years) in our minds, let us develop some quick approximations.
The rough math for a 7-7.5% inflation implies prices will approximately go up by
- 1.4x or 40% up in the next 5 years
- 2x in the next 10 years
- 3x in the next 15 years
- 4x in the next 20 years
From here you can build for all incremental 5 years using the logic that prices double in every 10 years. So for 25 years, we know that in 15 years prices are 3x and hence for 25 years it is 3×2= 6x. For 30 years it will be 4x (for 20 years)*2 (for the next ten years) = 8x
So just remember 1.4x, 2x, 3x and 4x (these are approximations but works fine as anyway planning for the future in itself is an approximation exercise)
How do we use this?
Let us assume your kid is 2 years. You estimate the current cost of under grad to be around Rs 10 lakhs.
So now without using an excel, you can quickly approximate the education cost of your child after 15 years to be 3x of 10 lakhs i.e 30 lakhs.
If your monthly expenditure is Rs 50,000 today then it becomes
- 40% up i.e Rs 70,000 after 5 years
- 2x i.e Rs 1,00,000 after 10 years
- 3x i.e Rs 1,50,000 after 15 years
- 4x i.e Rs 2,00,000 after 20 years
If someone’s salary is Rs 30,000 today and in the next 5 years it becomes Rs 42,000. Should he be happy?
Of course not. Our short cut calculations, indicate his salary just to account for inflation should have grown by 40% i.e from Rs 30,000 to Rs 42,000. This means his actual salary hike across the years in reality has been zilch!!
You get the drift. So go ahead calculate all your future costs while you are waiting in the next signal on the road 🙂
Short cut 2: Putting future values in perspective
i.e to equate future values to today’s costs at 7-7.5% inflation
- Today’s value of the money you get after 5 years = 70% of the money (accounting for inflation)
- Today’s value of the money you get after 10 years = 50% of the money (accounting for inflation)
- Today’s value of the money you get after 15 years = 35% of the money (accounting for inflation)
- Today’s value of the money you get after 20 years = 25% of the money (accounting for inflation)
So if your insurance agent promises lets say Rs 40 lakhs in 15 years, you should think of it as 35% of 40 lakhs i.e 14 lakhs in today’s terms. So whatever 14 lakhs can buy you today, will be what this 40 lakhs can buy you in 15 years.
Use these 2 thumb rules to quickly calculate your future requirements post inflation and to put future values in proper perspective.
But what if we can do an entire financial planner within 5 minutes in our head. Wouldn’t that be super awesome. Hang on till the next week, I have got you covered!
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