What’s your personal inflation rate?

Using the official CPI inflation for your financial plans can leave you short of your targets

The inflation rate that you assume in your calculations is one of the most important inputs to your financial planning exercise. If your assumed inflation rate turns out to be even 1-2 per cent short of the actual inflation that you experience, it can throw a spanner into the works on getting to your goal. This makes it is necessary to put more thought into your inflation assumptions in financial planning.

Official versus personal rate

The monthly Consumer Price Index put out by the government is the most widely used measure of inflation trends in India. The April 2019 release shows that inflation has averaged 4.8 per cent in the past six years. But if you are thinking of using this number in your financial plans, you should be aware that the official CPI is likely to be substantially understating the personal inflation you experience.

The CPI tries to capture the inflation for the typical household in India which earns a very modest income. Its weights to different goods and services reflect the spending pattern of a low-income household. The index, for instance, assigns a weight of nearly 46 per cent to food and beverages, but only 10 per cent to housing and 25 per cent to transport, health, education and recreation all put together. But middle- to higher-income folks are likely to spend a far smaller proportion of their monthly budget on food and far more on housing and services.

Given that food prices have been deflating lately while prices for services have been galloping, the official CPI has tended to understate inflation for the typical investor. So while the CPI shows that food prices have inflated at just 4 per cent in the last six years, housing has experienced 7 per cent inflation, education 6.3 per cent and healthcare expenses 5.8 per cent. It, therefore, makes sense to take your inflation cues from the services component of the CPI rather than the food component.

Whether you live in an urban or rural area and the State of your residence, too, can make for a wide divergence between your personal inflation rate and the official one.

In the year to April 2019, city dwellers in India experienced a 4.2 per cent inflation rate compared with 1.8 per cent for their rural counterparts. States such as Telangana, Andhra Pradesh, Chhattisgarh and Odisha reported CPI inflation of 1-2 per cent, while Karnataka and Kerala saw inflation of over 5 per cent. Therefore, while making your personal financial plans, it would be best to add a buffer of 2 per cent to the official rate if you are a city dweller or a resident of these Southern States.

But for more accurate estimate of your personal inflation rate, your best bet is to start tracking your monthly household expenses closely, so that you can compute the inflation specific to your situation. There are several personal finance apps that help with such tracking. This can help you capture the impact of not just the price rise but also lifestyle changes on your monthly spend, which is critical to your financial plans.

Getting real

Using the above methods to arrive at a personal inflation rate is useful when you are planning towards goals such as retirement. But if you are investing towards a specific goal such as your child’s education, buying a home or funding your healthcare, your inflation assumptions need to match the price rise in that particular asset class.

Take higher education for your children, for instance. While most financial calculators throw up a target based on assumed inflation rates of 7-8 per cent, you may need to budget for a higher number if you’re aiming for premier educational institutions in India. In 2012, a general-category student pursuing engineering at the government-subsidised IITs had to shell out ₹50,000 a year in tuition fees; but today, the fee has shot up to over ₹2 lakh. That’s a 22 per cent inflation rate in this period. BITS Pilani builds up to a 15 per cent annual increase into its fee structure for undergraduate courses. The course fee for a post-graduate management degree at IIM-Ahmedabad has risen from ₹16.5 lakh to ₹23 lakh over the past five years. In contrast, fees for middle-rung engineering or management institutes have risen at a far lower rate. So, the inflation rate you would assume for your education goal would vary quite a bit based on what you’re aiming for. If you are set on an overseas education for your child, you’ll have to factor in rupee depreciation of 4-5 per cent in addition to the inflation on course fees.

If buying a home is an aspiration, inflation trends in property prices in the city or locality of your choice is what you should be factoring in, rather than generic inflation rates. The National Housing Bank’s Residex tells us that while property prices in Delhi and Gurugram flatlined between 2013 and 2018, those in Bengaluru increased at an annual rate of 7.4 per cent, Hyderabad at 6.9 per cent, Kochi and Vizag at 7 per cent, and Chennai at 5.3 per cent in this period.

Budgeting for a 6-7 per cent inflation rate can leave you well short of funding healthcare expenses, with healthcare costs in India racing at double digits in recent years. If you’re looking to build up a fund towards sudden healthcare expenses, it would be safe to assume a 10 per cent inflation rate. The escalation in your health premiums gets steeper with age.

Overall, to get to the right inflation number for your financial plans, do collect real-life data on price trends, rather than going by ballpark assumptions based on the CPI.

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