Returns, Inflation and the Power of Compounding
On this page 9 headings
Start here Your uncle says, “I made 48% on my flat in 5 years — almost 10% a year!” Did he really? And did he even beat rising prices? This page teaches you to check.
Inflation: the silent killer
Inflation means prices rise over time. The same money buys less: your purchasing power falls.
Why does it happen? Too much money chasing too few goods. When supply is short and people have lots of cash, prices go up.
| Item | Earlier | Later |
|---|---|---|
| 1 litre of milk | ₹25 (10 years ago) | ₹40–45 |
| 1 litre of petrol | ₹60 (15 years ago) | ₹100 |
Lecture example — the same salary, half the petrol Salary ₹25,000. Petrol at ₹100 a litre → you can buy 250 litres. 15–20 years later, petrol is ₹200 → the same ₹25,000 buys only 125 litres.
Inflation is not all bad
| Good side | Bad side |
|---|---|
| Interest rates rise, so FDs pay more | Loan interest also rises |
| Salaries rise | It costs more to make things |
| It is a sign the economy (GDP) is growing | Too much inflation hurts growth |
How much is inflation in India?
- Measured by the CPI (Consumer Price Index).
- Long-term average: about 6–7% a year.
- Education inflation: about 10%. Healthcare inflation: up to 15%.
Lecture example — the grocery bills The lecturer kept bills for groceries he donated to a care home in 2008, 2013 and 2018. Moong dal: ₹50 (2008) → ₹90 (2013) → ₹92 (2018). That is about 12.5% a year for the first 5 years and 6.3% a year over 10 years. Average food inflation came to about 7.4%. During the pandemic (2018–2020), it went above 10%.
Why this matters: an FD gives 6–7%. After 20–30% tax, you keep about 4–5%. Food inflation is about 7%. So money in FDs is actually losing value.
Also: bank deposits are insured only up to ₹5 lakh per bank, so don’t put all your money in one bank.
Learn more for free: Investopedia (“what is inflation”) and Napkin Finance.
Return on investment (ROI)
ROI (%) = Net profit ÷ Cost of investment × 100
Net profit = selling price − cost price − expenses − taxes.
Always check:
- Simple ROI
- Annualised return (the CAGR)
- Benchmark return: did your fund manager beat the market index?
- Post-tax real return: after tax and after inflation.
Active vs passive investing
| Passive | Active |
|---|---|
| ETF (Exchange Traded Fund) or index fund: buys all companies in an index (Nifty 50, Nifty 100…) in the same proportion | A fund manager picks the best stocks |
| Low cost; you get the benchmark return | Costs more; worth it only if the manager beats the benchmark |
Simple interest vs compound interest
₹100 at 10% a year:
| Year | Simple interest (interest on ₹100 only) | Compound interest (interest on the growing total) |
|---|---|---|
| 1 | ₹110 | ₹110 |
| 2 | ₹120 | ₹121 |
| 3 | ₹130 | ₹133.10 |
The gap looks small at first, but over 20–30 years it becomes huge.
CAGR: the true yearly growth
CAGR = Compounded Annual Growth Rate: the steady yearly rate that turns your start value into your end value.
Lecture example — Mr. Vijay’s flat Mr. Vijay bought a 15-year-old 2BHK in Chennai for ₹1 crore in December 2017. He sold it for ₹1.5 crore in December 2022 (5 years). He paid ₹2 lakh brokerage. (Tax is ignored here.)
- Gain = ₹50 lakh − ₹2 lakh = ₹48 lakh → simple ROI = 48%.
- “Per year” the simple way: 48 ÷ 5 = 9.6%. Most people stop here.
- CAGR: (148 ÷ 100)^(1/5) − 1 = 8.16% a year.
The real yearly return is 8.16%, not 9.6%. That is 1.44 points less, or about 15% lower. And 8% is barely above food inflation of 7%.
How to calculate CAGR easily:
- A free financial calculator app (TVM, Time Value of Money): enter −100 (money out), 148 (money in), 5 years, compounding yearly, then press “rate” → 8.16%.
- Or Google Sheets / Excel.
XIRR: for SIPs with many dates
With an SIP, you invest every month, on different dates. CAGR can’t handle many dates. Use XIRR (extended internal rate of return) in Excel or Google Sheets.
Lecture example — SIP returns Long-term SIPs in mutual funds gave the lecturer about 15–21% a year (e.g. 19.74% for 2010–2015), much more than the flat’s 8.16%.
Do this for every asset you own: FDs, insurance, real estate, mutual funds, shares. Use post-tax values.
In one line: Inflation silently eats your money, so measure every investment by its CAGR (or XIRR for SIPs) after tax and inflation. Exam words: inflation, purchasing power, CPI, silent killer, ROI, net profit, CAGR, simple interest, compound interest, ETF, passive vs active, benchmark, XIRR, post-tax real return.