Finance

What is the formula for calculating inflation and how to calculate it?

Inflation refers to the rise in prices of goods and services over time. It reduces the purchasing power of your money. Calculating the inflation rate helps you make better investment decisions and protect your money from losing value. Read on to find out more about inflation and how to calculate the same.

What is the formula for inflation?

The formula to calculate inflation is:

Inflation Rate = (Current CPI – Previous CPI) X 100 / Previous CPI

CPI refers to the Consumer Price Index which measures the average price of a basket of goods and services. You can find CPI data on the website of your country’s central bank or statistics bureau.

For example, if CPI was 175 last year and is 180 this year, the inflation rate is:

(180 – 175) X 100 / 175 = 2.86%

Why inflation matters

Inflation impacts your cost of living and erodes the value of your savings and investments over time. While modest inflation is normal in a growing economy, high inflation reduces people’s standard of living. Monitoring inflation helps you make prudent financial decisions.

How to adjust investments for inflation

Aim for returns that beat the long-term average inflation. If inflation rises, allocate more to equity mutual funds as they typically outpace inflation over time. When inflation slows, increase fixed income exposure to protect capital. You can also invest in inflation-indexed bonds and gold.

Use an inflation calculator

An inflation calculator helps you determine how much the value of your money has changed over time due to inflation. You enter an amount and two years, and it calculates how much that amount would be worth today simply due to inflation. This helps put historical values into perspective and make apples-to-apples comparisons.

Key points to know about inflation

Moderate inflation is common in a growing economy, typically ranging between 2-3% annually. Hyperinflation, usually over 50% per year, can disrupt an economy. Deflation refers to falling price levels which can also hurt economic growth. Historically, the rate of inflation has averaged around 3% per year. But it has ranged from as low as -15% to as high as 23% during hyperinflationary periods. Inflation in developing economies tends to be higher due to weaker currencies and economic factors. When inflation rises, the central bank usually hikes interest rates which helps control price increases by making it more expensive for businesses and consumers to borrow money. Higher rates also attract investors to fixed income, reducing the money supply.

Conclusion

Inflation erodes the purchasing power of money. By calculating inflation, monitoring price levels and adjusting your investments, you can make sure your money retains value over the long run. Equity funds, inflation-indexed assets and gold help hedge against high inflation. When inflation slows, fixed income provides capital preservation. An inflation calculator provides historical context for comparing dollar values over time. Staying on top of inflation is key to achieving your financial goals.

In summary, understand how inflation impacts your money and investments, mutual funds or otherwise. Take steps to not just beat but outpace inflation over the long run. Make prudent adjustments to your portfolio and use the relevant tools to make informed decisions. With the right strategy, you can overcome the wealth-reducing effects of inflation.

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