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You earn interest when you invest your money in a financial instrument. There are multiple ways of calculating interest but the two most popular ones are simple and compound interest. In simple interest, you earn interest on the original principal amount, whereas in compound interest, each subsequent interest calculation is done on the principal plus any accrued interest. Compound interest multiplies your money faster but is it sufficient to beat inflation?
Key Takeaways
Compound interest makes money grow faster, but its effect is diminished if inflation is not factored in
A 6% return with 6% inflation gives you only a 0.76% real return scarcely wealth-creating
Saving up for big-ticket purchases is usually wiser than borrowing, saving you interest expenses in the long run
ELSS and ULIPs provide inflation-beating potential with tax-saving advantages and long-term growth
Tax-adjusted, inflation-aware investing is the sole path to real, enduring financial security
Choose flexible, growth-focused plans with equity exposure and insurance cover in one place, perfect for constructing your tomorrow, today
Calculate Compound Interest with Inflation
In compound interest, the interest earned is added back to the principal before calculating the interest in the next round. So, if the bank has offered you quarterly compounding on your money, the interest earned in quarter 1 would be added to the principal before calculating interest in quarter 2.
The effective yield actually is much higher than the quoted rate of interest in the compounding interest method. It is not uncommon for banks and financial institutions to quote effective yield for investments so that investors are aware of the actual growth.
For example: If you invest ₹100 at a compound interest of 6% per annum, compounding being done quarterly, the amount at the end of 5 years would be ₹134.686 (effective yield: 6.94%)
If the compounding is done annually, the final amount on maturity would be ₹133.823 (effective yield: 6.76%)
However, this rate of growth does not signify real growth because the value of money gets eroded over time due to inflation. As of July 2022, the inflation rate in India was 6% which implies:
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Why Consider Inflation with Investments?
The above example of investing ₹100 was very simplistic. As a serious investor, you may be aspiring to build wealth in the medium to long run. If you invest some lump sum money such as ₹10 lakhs, that you received as a performance bonus, etc., at a 6% rate of interest in a bank FD, you will receive ₹13,46,855 at the end of 5 years.
In the real world, you must also factor in taxation, because interest earned on FDs is taxable. If you fall in the 20% tax bracket, you will end up paying ₹69,371 towards income tax. You are effectively taking a post-tax return of 5.55% or ₹2,77,484. (total amount of ₹12,77,484). If the inflation rate is 6% and your earning is 5.55%, your real earnings = 5.55%-6%= -0.45%
The buying power of your money goes down with time. To ensure your hard-earned money does not lose its sheen, it must grow faster than the rate of inflation. Invest accordingly.
Must Read - Compound Interest Investments
Why Saving is Better Than Borrowing for Large Purchases?
If you are planning to buy a car worth ₹10 lakhs and have two choices in front of you:
Your banker offers you a car loan at 7.5% per annum under the reducing balance method. The loan repayment tenure would be 5 years (60 months).
You save ₹20,000 each month and invest the same at, let's say, 6% per annum in a modest recurring deposit.
Which one should you opt for?
Let’s take scenario #1. If you avail yourself of a loan, you end up paying a total interest of ₹2,02,277 in 5 years.
Loan Amount (₹)
₹10,00,000
Monthly Payment (₹)
₹20,038
Total Interest (₹.)
₹202,277
Total Payment (₹)
₹12,02,277
In scenario #2, your ₹10 lakh investment grows to ₹14.01 lakhs over 5 years, potentially more with superior options like ULIPs that offer market-linked returns beating fixed deposits after inflation.
Saving money to buy a car makes more financial sense.
Did You Know?
India's inflation plummeted to a provisional 1.33% in December 2025, marking a massive shift from the 6.71% peak seen in July 2022.
Source: PIB
Best Long-Term Investments for Beating Inflation
Invest in avenues that will beat inflation and help you generate wealth. ELSS and ULIPs are proven to give inflation-beating returns over a 3–5-year period:
Equity Linked Savings Scheme (ELSS)-In ELSS, you calculate the compound interest using the formula for Compounded Annual Growth Rate (CAGR). For example, if you invested in an ELSS with a Net Asset Value (NAV) of ₹50 and the NAV becomes ₹100 in 5 years, the CAGR = {[(100/50)^(1/5)]-1}*100 = 14.87%.
Other features of ELSS which make it useful for beating inflation in the long run are:
Invests primarily in equity stocks
Investments are tax-deductible
Long-term gains are tax-free up to ₹1 lakh in the year of withdrawal
Has a short lock-in period of just three years
You can invest and withdraw systematically
No maximum limit of investment
Unit Linked Insurance Plans (ULIPs)- ULIPs also work on the principle of CAGR. In ULIPs with annual premium payments, the premium is added to the previous fund.
ULIP investments offer more flexibility and options to you as a diversified investment. Here are the features of ULIP plans you should consider:
Invest in a mix of equity and debt funds
Use automated strategies for managing your asset mix as per market
Added bonuses for long-term investors
Switch from equity to debt or debt to equity anytime without a tax liability
Tax-free partial withdrawals are available after five years of investment
You can build a large corpus and have a tax-free pension after 60 with a single plan
No maximum limit for investment; however, the tax-exempt status applies only for investments up to ₹2.5 lakh per annum
Inflation-Beating Investments for Wealth Preservation
Investments in both ELSS and ULIPs are deductible from your taxable income under Section 80C. The maturity amount, in ULIPs, is also exempt from taxes. So, that’s an additional saving for you. Both ELSS and ULIP are wealth-building investments. Once you have built the wealth you need to preserve it using large assets like real estate or savings plans.
Saving is essential but what is critical is investing in the right asset classes and financial instruments. Your investments should yield inflation-beating post-tax returns. Tax rebates on investment and maturity will save considerable money. Saving and making large purchases with your savings is better than buying things on credit.
Conclusion
In the long inflation vs. returns race, compound interest by itself cannot assure your financial win, unless combined with the proper investment options. Conventional saving instruments provide security, but they tend to lose against the insidious, steady nibble of inflation, particularly after tax withholding. To really protect and increase your wealth, you require solutions that save and perform better. Alternatives such as ELSS and ULIPs not only provide market-linked growth but also have tax-efficient benefits that can assist you in creating a strong financial future. Through our thoughtfully designed plans, we aim to support you in saving, securing, and growing your financial future with confidence. The earlier you begin your investment journey, the greater the potential advantage of compounding over time.
Glossary
Inflation: The rate of increase in the general level of prices and cost of living measured by a basket of goods and services
ULIP (Unit Linked Insurance Plan): A hybrid product that combines insurance and market-linked returns
ELSS (Equity Linked Savings Scheme): A tax-saving mutual fund scheme that invests in equities, providing growth
Real Return: The after-tax profit after inflation has been adjusted for investment returns, reflecting real purchasing power
Effective Yield: The actual return on an investment, taking into consideration compounding periods and presented every year
FAQs
Compound interest can beat inflation only when the return rate is higher than inflation after taxes. Otherwise, real purchasing power still declines over time.
You subtract the inflation rate from your compounded return. Many investors use a compound interest calculator with inflation to estimate real returns.
Equity-linked options like ELSS and ULIPs offer better long-term compounding potential and are among the best compound interest investments for beating inflation.
Inflation compounds annually, meaning prices rise on previous increases. This compounding inflation is why savings must grow faster to retain value.
Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.
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