Inflation and your Money...

Inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices. The boundary between inflation and deflation is price stability.

The Link Between Inflation and Money
Because inflation is a rise in the general level of prices, it is intrinsically linked to money, as captured by the often heard refrain "Inflation is too many dollars chasing too few goods". To understand how this works, imagine a world that only has two commodities: Oranges picked from orange trees, and paper money printed by the government. In a year where there is a drought and oranges are scarce, we'd expect to see the price of oranges rise, as there will be quite a few dollars chasing very few oranges.This scenario is INFLATION. Conversely, if there's a record crop or oranges, we'd expect to see the price of oranges fall, as orange sellers will need to reduce their prices in order to clear their inventory. This scenario is DEFLATION. though in the real world inflation and deflation are changes in the average price of all goods and services, not just one.

Inflation is caused by a combination of four factors:

1. The supply of money goes up.
2. The supply of other goods goes down.
3. Demand for money goes down.
4. Demand for other goods goes up.

In Other words....to understand this phenomenon of INFLATION..we take an Example..
my dad decided in his childhood to save 50paise thinking, that one day when he becomes big, he will go for a movie. Many years pass. The year now is 2006. My dad goes to the theater and asks for a ticket. He offers the ticket-booth-guy at the theater 50paise and asks for a ticket. The ticket booth guy says, “I am sorry sir, the ticket is worth Rs.50. You will not be able to even buy a “Chocolate” with the 50paise!!”

The moral of the story is that, the worth of the 50paise reduced dramatically. 50paise could buy a whole lot when my dad was a kid. Now, 50paise can buy nothing. This is inflation. This tells us two important things.

CONCLUSION

Firstly: Do not keep your money stagnant. If you just save money by putting it your safe it will loose value over time. If you have Rs.1000 in your safe today and you keep it there for 10years or so, it will be worth a lot less after 10 years. If you can buy something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years from now. So do not keep money locked up in your safe.

Always invest money.

If you can’t think where to invest your money, then put it in a bank. Let it grow by gaining interest. But whatever you do, do not just lock your money up in your safe and keep it stagnant. If you do this, you will be loosing money without even knowing it. The more money you keep stagnant the more money you will be loosing.

Secondly: When investing, you have to make sure that the rate of return on your investment is higher than the rate of inflation.
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What is the rate of inflation?
As we said earlier, the prices of everything goes up over time and this phenomenon is called inflation. The question is: By how much do the prices go up? At what rate do the prices do up?

The rate at which the prices of everything go up is called the "rate of inflation". For example, if the price of something is Rs.100 this year and next year the price becomes approximately Rs.104 then the rate of inflation is 4%. If the price of something is Rs.80 then after a year with a rate of inflation of 4% the price go up to (80 x 1.04) = 83.2

So, when you make an investment, make sure that your rate of return on the investment is higher than the rate of inflation in your country. In our county India, for the year 2005-2006 the rate of inflation was 4% (Which is really low and amazing!). This rate keeps changing every year. The finance minister generally gives the official statement on the inflation rate of the country for a particular year.

What is the rate of return?
The rate of return is how much you make on an investment. Suppose you invest Rs.100 in the market and over a year, you make Rs.120, then you rate of return is 20%.

If you invest Rs.100 in the market today and you make money at a 3% "rate of return" in one year you will have Rs.103. But now, since the rate of inflation is at 4%, an item costing Rs.100 today will cost Rs.104 a year from now. So what you can buy with today’s Rs.100, you will only be able to buy with Rs.104 a year from now.

But the Rs.100 that you invested has grown only at a 3% rate of return and so it is worth Rs.103. In effect, you are loosing money!

So in conclusion, the rate of return on your investments, have to be higher than the rate of inflation.

From the above paragraphs you can note how silently, inflation eats into your money. You would not even know about it an your money would sit loosing value for no fault of yours.
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