In college, I used to plug numbers in an SIP Calculator and drool over the wealth I would end up with. The power of compound interest is fascinating, and I would 100% agree with calling it the 8th wonder of the world.
But those weren't real numbers because I never considered inflation. For example, without inflation, a SIP of Rs. 1,00,000 monthly for 30 years at 15% would result in Rs. 70,00,00,000 (or 70 Cr). The same with 5% inflation would be Rs. 20,00,00,000 (or 20 Cr).
When you see Rs. 70 Cr as a number, you start imagining all the things you could buy today with that. That's how the human brain works. But it's a hoax. Sure, it's good for motivating and convincing you to start SIPs, but still, it's misleading. Since we imagine the terminal value of what SIPs generate as we can spend it today, it's better to focus on the Rs. 20 Cr because the goods and services one can buy with Rs. 20 Cr today would be equivalent to what one can buy for Rs. 70 Cr after 30 years.
I found other things missing in most calculators, like increasing the monthly SIP amount yearly and stopping increments after a point to simulate what happens in the labour market. People keep getting increments until it reaches a plateau.
SIP Calculator: https://fintools.bauva.com/sip
Inflation is even more crucial when taking home loans in particular. When you take a loan for, let's say, an EMI of Rs. X. That X money is significantly more valuable right now than it would be valuable after 30 years. To give a more concrete example, let's say your parents bought a house 30 years back for Rs. 5,000 EMI and let's say it was 30-50% of their combined salaries. That same EMI would be less than 2% of their combined salaries today.When you borrow money in a high inflationary environment, it's highly advantageous because you are using cheaper future money to pay back older expensive money.
Let's take the example of borrowing Rs. 2,00,00,000 (2 Cr) at 8.5% for 30 years. The EMI comes out to Rs. 1,53,782. And the total amount repaid would be Rs. 5,53,61,770 (5.53 Cr). On the face of it, it looks like you spent a lot on interest. However, considering 4% inflation, the total real amount repaid comes to Rs. 3,23,18,886 (3.23 Cr), and the present value of the last EMI instalment is Rs. 46,565. The first EMI instalment would take away a significant portion of your paycheck, but the last instalment wouldn't.
EMI Calculator https://fintools.bauva.com/emi/home-loan
So what values of inflation to use?
I like to take the govt data and add 2% when I am using it for assets and I subtract 2% when using it for liabilities. It's called the conservative principle of business. Overestimate your expenses/liabilities and underestimate your assets/income. Being conservative has served me well.
Disclaimer: Before you start doing financial jugglery, you must ensure you provide value to the world that isn't easily replaceable. That's the best way to survive whatever the macro environment is. Financial jugglery can't bypass this, but it can aid it.
