One can never escape the web of economic factors and how they affect your personal finance. One news about the economic crisis and everything gets thrown out of the window. All the plans, investments, saving decisions you made seems like a mistake.
It becomes prominent to understand why all this happens. How it happens? Can we do something to safeguard ourself? That is why I bring the information detailing how some of the economic factors can affect your personal finance.
In the previous blog posts I covered the basic concepts of micro and macro economics. Both, micro and macro economic factors are crucial for the economy and hence crucial to manage our money.
Here are the economic factors and how they affect your personal finance:
Inflation and its effects:
Simply put, inflation is when there is huge liquidity in the economy and prices of commodities go up significantly. This creates a whole lot of problems. Why? because if you have single or fixed source of income then you plan your monthly expenses, savings and investments accordingly. Even a slight change in all the essential goods will lead to spending more on expenses leaving comparatively less amount for saving and investing.
This general rise in price also affects your return on investments. When you invest money, you expect certain returns but that is notional return. To determine the real rate of return we need to check the inflation rate and any taxation.
For example, while investing the notional rate of returns is 9%. The inflation is 6% and the investment is not a tax free hence invites 2% in taxes. Now when the investment period is completed and maturity amount is received, we are just getting 1% in returns instead of 9%.
Why so? Because, the inflation hikes prices. If you buy something for a certain price, due to inflation the price of that product will increase by 6%. That means your appreciated savings will get eaten up by inflation. Moreover, taxation is also crucial while making investments. Therefore, always check whether the investment scheme is tax free or not.
On the other hand, the governments try to curb the inflation by raising the interest rates. This allows you to keep your money in savings. But the downside is that the money gets locked out for a certain period of time. Withdrawing such savings before time would require you to pay penalty for pre-mature withdrawal.
All in all, the inflation affects your savings and investments heavily. So it is good to keep an eye out for the inflation rates while choosing an investment scheme.
Gross Domestic Product (GDP) and its effect:
GDP is something for which countries put in all the efforts. This is an indicator which show the progress of a country whether they are on the path of progress or on a derailed path.
But how does it affect my personal finance? In theory, the GDP comprises of all the products and services produced by the country. Going in detail, GDP is not the stand alone indicator. If we subtract the imports and foreign debts we get Net Domestic Product (NDP) , you divide that by the total population you get Per Capita Income (PCI) and so on.
In practice, the GDP shows how much the country was able to produce, export and how much the country had to rely upon foreign imports and debts. Moreover, it shows the strength of the currency. If the GDP is rising year on year that means economy is developing. A growing economy directly correlates to your personal finance.
Sluggish economy means higher oil and petrol prices, less job opportunities and lower interest rates. That means whatever you save and invest does not even match up with the inflation rates.
Generally, to keep up in such scenarios, one must check for schemes which imitate the index prices. A scheme that invests in index funds, government bonds, etc. This is safe investment and also when the economy recovers your investments pay off even better.
Read about the basic concepts of macroeconomics by clicking here.
The basic concept of opportunity cost dictates that for while investing you may have multiple options to choose from but limited money to invest hence you can only choose only 1 option. The cost of not choosing another option is called ‘opportunity cost’. The opportunity which you had but could not encash.
Over the period of time you realize and compare the returns generated by your investment vs. the alternate options. The impact that opportunity cost can just be the value that you could have received if you had selected alternate investment option.
Organizations always do a thorough analysis before making crucial decision like whether to produce something in-house or outsource it. For personal finance we also need to make sure that the money is invested in the best possible option.
For example, you are a conservative investor looking for a safe investment option. You have the age old option of Fixed Deposit, somewhat modern option of Debt Mutual Funds, Index funds, some LIC Money Back schemes, and others. If you choose FD gives 5.5% and the Debt Mutual fund gives 7% but you still decide to go for FD then at the end of maturity period you are already loosing 1.5% (7% — 5.5.%) which will be termed as ‘opportunity cost’.
Read the basic concepts of microeconomics by clicking here.
Other economic factors and their impact on personal finance:
Apart from the aforementioned economic factors there are some other important factors which affect your personal finance. Factors like foreign exchange rates, stock market fluctuations, monetary policies, etc.
These factors affect the global markets, countries, companies, and then the life of common public. One must always stay up to date with these factors to anticipate the upcoming wave and safeguard against it. Because no matter what sector you are working for when the economic crises hits, everybody experiences the impact.
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