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Funny Money

Welcome to my blog, Money Illusion – People think of money in nominal terms ie what is its face value ( say ten thousand rupees ) rather than what it can buy in real terms.  Fiat Money ( ie money created by governments has no inherent value except as  a medium of exchange) is never nominal but real, ie  as a medium of exchange what it can buy one day to another keeps varying rapidly.  Most economists tell us that people make rational decisions but it is not so. Experiments have shown that people generally perceive a 2% cut in salary  as unfair, but see a 2% rise in salary when  inflation is 4% as fair, despite them being almost rational equivalents.

When researchers asked people whether its better to get 2% raise with 4% inflation or 2% cut in salary with 0% inflation they found easily that both the choices are same but when asked  who would be happier  – they voted that the person who got raise would be !!.

The thing is while your logic understands its the same the brain wants the goddamn raise anyway (emotion) even though reason says its the same.  See : http://scienceblogs.com/cortex/2009/04/money_illusion.php

The point to ponder is when you think about money think of it in real terms and not in its face value, since its face value keeps changing all the time.  About 100 years back 13 Rupees could fetch you 8 grams of gold, today you need 14000 rupees approx.

Whats the takeaway for an investor in this ? when some one tells that invest x rupees every month to get some huge amount after a decade  – think about what it will be worth in real terms after ten years.  Yogi Berra got it right as usual when he said that ” A Nickle isnt worth a dime anymore”

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