By IndiaHub 
Let us understand it with an example. If a Rs 5 lakh lump sum investment growing at a 8 per cent annualised return increases to nearly Rs 50.32 lakh (over 10 times) in 30 years. However, one aspect that we often forget is the impact that inflation will have on this corpus over a long period. Will Rs 50.32 lakh after 30 years have the same purchasing power as the same money in hand today? No, it will be able to buy goods worth much lesser value due to inflation as the time progresses.
Similarly, if you invest Rs 10,000 monthly in an SIP for 20 years in an instrument providing a 8 per cent annualised return the value of your investment 20 years down the line will be Rs 56.89 lakh. However, this money after 20 years, will not be able to buy goods which are worth Rs 56.89 lakh today but much lesser.
How inflation adjusted rate of returns helps you in getting real value of your investment
Your investments grow at one pace, and inflation at another. When you adjust both against each other, you can calculate inflation-adjusted return. For real value estimate when you incorporate impact of inflation into it, it gives you the inflation-adjusted value of the final corpus, which is significantly lower than the calculated nominal corpus.
Also Read: How to turn your SIP into Rs 1 crore faster
Formula to calculate inflation-adjusted return
Inflation-adjusted return (%)= (1+investment return rate%)/(1+inflation rate%)-1 * 100
Now if the annualised return on your investment is 8 per cent and the inflation rate is 5 per cent, the inflation-adjusted return will be 2.86 per cent.
Calculating return without inflation
If you start an Rs 10,000 monthly SIP investment where the annualised return is 8 per cent, let’s see the corpus you may create in 25 years.
In 25 years, the total investment will be Rs 60,00,000, estimated capital gains will be Rs 31,48,394.34, and the estimated corpus will be Rs 91,48,394.34.
Also Read: With Rs 15,000 monthly SIP, can I build a corpus of Rs 1.5 crore in 14 years?
Calculating return with inflation adjustment
If we take inflation into account with an inflation rate of 5 per cent, the estimated inflation-adjusted value of the corpus will be Rs 43,60,137.85. What it means that the Rs 91,48,394.34 after 25 years is only worth Rs 43,60,137.85 today when it comes to purchases power.
Similarly, if the inflation rate is 6 per cent, the inflation-adjusted value of the same investment will be much lower Rs 38,27,167.75.
This is the pre-tax value of the corpus. The value can be less after paying tax.
What may be way out to beat inflation
While calculating inflation-adjusted corpus gives you an idea about the present value of a future amount. If it is not sufficient, you may need to keep revising your investment strategy to get a desired corpus.
If one remains conservative in their investment approach, they may not be able to beat inflation significantly in the long run. This happens when you rely mostly on debt or fixed income instruments. If you need a higher return to reach your inflation-adjusted corpus target you may need to add equities in your investment portfolio as equities are known to deliver higher returns in the long run. So, one may have a mix of equity and debt to maintain growth and stability in their long-term investment portfolio.
What should you do?
While inflation will eat out a large portion of your investment return and a Rs 10,000 monthly SIP investment can be way short of your desired retirement corpus, a fine method to counter inflation can be to have a mix of equity and debt in your investments and to increase the investment amount with income.