Inflation as a first-class citizen in financial tools(bauva.com)
bauva.com
Inflation as a first-class citizen in financial tools
https://bauva.com/blog/financial-tools-inflation/
5 comments
You have sharp financial skills. I predicted this comment, so I added a disclaimer that one should be providing high value to society, which isn't replaceable. If one does that, the source of funds will go up more than inflation.
The effect of inflation is only relevant for home loans or for infrastructure projects like building bridges, buildings, factories, etc.
The effect of inflation is only relevant for home loans or for infrastructure projects like building bridges, buildings, factories, etc.
I'll also add, you definitely shouldn't assume a 2% inflation rate. I would bank on 3.5% or higher in the long run.
I never assume a 2% inflation rate. I live in India, so I add/subtract 2% from the government's declared inflation numbers. If the government says inflation is 4%, I will use 6% for assets and 2% for EMIs.
In developed countries, maybe I would add 1-1.5%
In developed countries, maybe I would add 1-1.5%
For simple back-of-the-evelope stats like a saving calculator, don’t you just need to subtract inflation from expected returns to get the number?
If you’re expecting 7% returns and 3% inflation, just enter in 4% returns and then you’ll see the final estimate in “inflation corrected” today’s dollars. Right?
If you’re expecting 7% returns and 3% inflation, just enter in 4% returns and then you’ll see the final estimate in “inflation corrected” today’s dollars. Right?
True for SIP. That does give a somewhat accurate number. For knowing the present value of the last EMI, it doesn't help, though.
I agree with the reasoning but this doesn’t discuss any tools that include inflation nor any tips or suggestions in integrating it into your own tools.
The links don't seem to be obvious.
SIP: https://fintools.bauva.com/sip/ EMI: https://fintools.bauva.com/emi/home-loan
Thanks for notifying me; I have now updated the blog post, making the links explicit.
SIP: https://fintools.bauva.com/sip/ EMI: https://fintools.bauva.com/emi/home-loan
Thanks for notifying me; I have now updated the blog post, making the links explicit.
It should be implicit whenever you use a compound interest calculator that you’re interested in today-dollars, not future-dollars.
So any interest rate you estimate should already have inflation factored in.
So any interest rate you estimate should already have inflation factored in.
Using (absolute interest rate - inflation) as the real interest rate is a good enough approximation, but the present value of the last EMI payment would be impossible to obtain.
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This is only true under the assumption that the *source* of the money that you are paying back the loan with appreciates.
For example, consider taking out a loan that requires $1,000 monthly payments over 30 years. Assume that you pay back this loan with your labor (i.e., income from your job), and let's suppose you make $100K/yr. Most people can think of their jobs as an appreciating asset as long as they are receiving standard C.O.L. raises. However, suppose that 30 years later, you are still making the same exact $100K salary. Then, although you are "paying back your loan with cheaper dollars," the impact of making those loan payments is actually the same in terms of your buying power.
Year 1: $1,000/month (inflation-adj. salary = $100,000; relative impact on buying power = 12K/100K = 12%) Year 30: $1,000/month (inflation-adj. salary = $36,254; inflation adjusted payments is $4,950; relative impact on buying power = 4950/36250 = 12%)
^ this is assuming a 3% inflation rate.
Note that almost everyone is getting C.O.L. raises, especially over 30-year time spans. However, this point is especially relevant for shorter term loans, and for people who may not experience wage increases.