Monday, February 2, 2009

Inflation : The Silent Threat - Part 2

What are the Effects of Inflation?

Although inflation can be considered a normal economic development as long as the annual percentage remains low, it can cause a crisis once the percentage rises over a pre-determined level. The most obvious way it can affect your personal finance is by significantly reducing your purchasing power. You will find that the price of everyday products and services rising and with interest rates going up as well, loans will often cost more.

For example :

- In 1978, RM300 can buy one month's worth of groceries for a family of four.

- In 2008, RM300 can buy one week's worth of groceries for a family of four.

- In 2028, RM300 can probably buy two day's worth of groceries for a family of four.

By understanding the difference between nominal returns and real returns, you will be able to see the impact of inflation will have on your funds. Nominal return refers to the growth rate of your money while real return is the growth of your purchasing power, which is the nominal return reduced by the inflation rate. Hence, monies that are placed in fixed deposits may lose their value over time due to the eroding effects of inflation.

For example :

12 months fixed deposit rate = 4%
Inflation rate (personal level) = 6%
Real return on investments = 4% - 6% = -2%

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