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Investment

What Inflation Does to Your Savings

The return that matters is what is left after inflation and tax. For many safe deposits, that number is close to zero.

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3 min read

The short version

  • Real return is roughly nominal return minus inflation — and it is what determines buying power.
  • Tax comes off the nominal return before inflation is subtracted, which hurts more than people expect.
  • Long-term goals must be inflated before you work out what to invest.
  • A salary increment below inflation is a pay cut in real terms.

The arithmetic that matters

Suppose a fixed deposit pays 7% and inflation runs at 6%. The balance grows, so it feels like progress. In purchasing power, you are almost exactly where you started.

Now add tax. For someone in the 30% bracket, a 7% deposit returns about 4.9% after tax. Against 6% inflation, that is a real return of roughly negative 1%. The balance rises every year and buys slightly less every year.

This is not an argument against fixed deposits, which do a specific job well — certainty and liquidity for money you may need. It is an argument against holding money you will not need for twenty years in something that cannot outpace inflation.

The arithmetic that matters
NominalAfter 30% taxAfter 6% inflation
Savings account at 3%3.0%2.1%−3.7%
Fixed deposit at 7%7.0%4.9%−1.0%
PPF at 7.1% (tax-free)7.1%7.1%+1.0%
Equity fund at an assumed 12%12.0%10.8% approx+4.5% approx

Inflate the goal before you plan for it

The most common planning mistake is working out what a goal costs today and investing to reach that number.

A college education costing ₹20 lakh today, at 8% education inflation, costs about ₹43 lakh in ten years. Planning for ₹20 lakh guarantees a shortfall of more than half.

The right sequence is: inflate the target to what it will cost when you need it, then work out what you need to invest to reach that figure.

Your personal inflation rate is not the headline number

  • The published consumer price index reflects a national average basket. Yours is different.
  • Education and healthcare have historically risen faster than the headline index. A household paying school fees and medical bills experiences higher inflation.
  • Rent, which is a large share of many urban budgets, moves differently from the index.
  • For planning purposes, many people use a higher assumed rate for education and healthcare goals than for general ones. It is a judgement, but it errs in the safer direction.

And in salary terms

A 5% increment in a year when inflation was 6% is a pay cut in purchasing power, however it is described in the appraisal letter.

This is worth calculating rather than assuming. Over several years of below-inflation increments, real income falls meaningfully even though the nominal number keeps rising.

Frequently asked questions

What inflation rate should I use for planning?
India’s monetary policy framework targets consumer price inflation at 4% with a tolerance band of two percentage points either side. Many people plan long-term goals at 6% to stay conservative, and use a higher figure for education and healthcare, which have historically risen faster.
How do I calculate a real return?
Approximately, subtract inflation from the post-tax nominal return. Precisely, use ((1 + nominal) ÷ (1 + inflation) − 1) × 100. Apply tax to the nominal return first, then adjust for inflation — doing it the other way round understates the damage.
Are fixed deposits pointless because of inflation?
No — they do a specific job well. Certainty and liquidity for money you may need within a few years is genuinely valuable, and no market-linked investment provides it. The mistake is holding money you will not touch for decades in an instrument that cannot outpace inflation after tax.

Sources

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