"Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, every pound buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value."
In the UK we often hear about the Retail Prices Index (RPI) and, of late, more and more about the Consumer Price Index (CPI). Both of these indices offer the means to quantify the rate at which inflation is increasing, or sometimes, decreasing.
The Retail Price Index was introduced in 1947 and is still used by the UK Government for some purposes such as the amounts payable on index-linked securities including index-linked gilts.
When calculating RPI, reference is made to ‘a basket of goods and services bought and used by the average family’ the cost of each item is found for the base year and also for the year (or month) in question and the rate of inflation is the percentage difference between the two.
The highest annual rate of inflation in theUKas measured by RPI was in 1975 when the rate peaked at 24.9% - but by 2001 it had fallen to an annual rate of 0.7 %.(Barclays Equity Gilt Study/FTSE).
The Consumer Price Index, which is becoming the most commonly referred to index, also use references to a basket of goods and services but crucially the following items are not included in the CPI; council tax, mortgage interest payments, buildings insurance etc. It is the CPI that the Government is now using as the basis to determine the annual increase in public service pensions in payment and various benefits.
Whilst these indices have traditionally provided the basis for measuring the effect of inflation on people’s spending power they have only been truly accurate if you happen to buy exactly the same goods and services that are included in the official calculations.
But what if your spending pattern is radically different?
What is YOUR rate of inflation?
The rate of increase in the cost of heating and of food, for example, is a lot higher than either RPI or CPI – some of the power companies have announced huge price increases in the last couple of weeks - EDF will increase their charges by around 11% from the beginning of December.
According to the Bank of England Inflation Calculator the average rate of inflation between 2001 and 2011 was 3.1%, which means that to buy the ‘value’ of £1 in 2001 you would need to spend £1.35 in 2011. If we go back 30 years, then to buy the ‘value’ of £1 in 1981 it would have cost you £3.14 in 2011.
So your investments must not only grow to provide for your future needs, they must also overcome the impact of inflation on your future spending power and not only that, where you are looking to start taking an income from, say, a pension scheme you need to consider how inflation will affect you during your retirement.
If you would to know more about how you can mitigate the effects of inflation on your investments please do not hesitate to contact us for an informal chat.