Purchasing Power

You might have come across the concept of purchasing power – well the idea is very simple it is your ability to buy goods or services expressed in units of money. The issue here is that Inflation will change your ability to buy effectively reducing your purchasing power over time. Here is a very useful calculator showing how the inflation rate will affect an average buyer [Inflation calculator].

UK Inflation

In the last 5 years, Inflation in the UK fluctuates between c.0 and c.3% so you may be thinking that it's not that significant as we tend to make the same mistake thinking only about 3 out of 100. Our brains however are not wired for accumulated loss and something that behavioural economists describe as perspective or descriptive theory. Let’s try now in your head to calculate how much the average inflation rate of 3% changed your £100 bill over the last 15 years. Well, the answer is that in order to have the same purchasing power we’ll need c. £155.

Coutts Luxury Price Index

The impact will be even more significant for HNWI as their typical basket of goods and services deviates from the average. RBS announced that Coutts Luxury Price Index (CLPI) rose by 5.9% for 12 months to the end of October 2018, more than double the earlier CPI of 2.4% as luxury goods are far more exposed to inflation than the average consumer. CLPI focuses on high-end items giving an accurate measure of the effect of inflation.

If you invested £10,000 at the start of the year in 1975 you would end up with £756,094 on June 30, 2013 (ignoring taxes) which gave an annual compound return of 11.9% (based on S&P500 return from Jan'75 to Jun'13). Understanding this together with the daily exposure of wealth to inflation and how that might affect you could help you plan ahead and protect the spending power of your or your client’s wealth.