Inflation has been high in India and it is important to provision for the same

It is aptly said, what compound interest gives, inflation takes away. Put it another way- inflation is effectively the reverse of compound interest - it's like decompound interest.

Since each year's inflation occurs on top of the previous year's inflation, it means that the effect is just like that of compound interest. Consider a situation where you invest Rs.1 lakh of your money in a deposit which earns you 8 per cent a year. At the same time, the prices are also generally rising at the rate of 8 per cent a year. In such a situation, your compounding returns will just about keep pace with the inflation.

The actual amount will increase, but what you can do with it won't increase in line. So, for example, over ten years your Rs.1 lakh will become Rs.2.16 lakh. However, at the same time, on an average the things you could have bought for Rs.1 lakh will also cost Rs.2.16 lakh. In effect, the purchasing power of your Rs.1 lakh is not what it used to be ten years ago. The rise in the amount of money you hold is just an illusion and is completely negated by a corresponding rise in prices.