How to calculate cash loss over time?
For example, I got £100 few months ago and I didn't spend them - just kept them in my drawer at home. I understand that those £100 from few months ago is not worth same £100 but it is less today. How exactly I can calculate current money value which I kept from the past?
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It helps to put the numbers in terms of an asset. Say a bottle of wine costs 10 dollars, but the price rises to 20 dollars a year later. The price has risen 100%, and your dollars have lost value. Whereas your ten used to be worth 100% of the price of bottle of wine, they now are worth 50% of the risen price of a bottle of wine so they've lost around 50% of their value.
Divide the old price by the new inflated price to measure proportionally how much the old price is of the new price. 10 divided by 20 is 1/2 or .50 or 50%. You can then subtract the old price from the new in proportional terms to find how much value you've lost. 1 minus 1/2 or 1.00 minus .50 or 100% minus 50%.
There are two things you need to keep in mind when you look at Inflation as an entity.
Inflation is necessary to keep in check the value of goods. As per Moore's Law for example, a mobile phone that you buy for £100 today will be available for £50 in two years. With increased purchasing power, one needs to maintain balance between the purchasing power and its value. If you think about the 'loss' at a rate of 2% you would have £96.04 (in terms of today's value) in two years. But if you looked at the same cell phone as leverage for your business where it allowed you to do work and earn £1000 in two years - the investment would clearly offset the cost of inflation.
Inflation is incentive for people to spend their money. If you for example spent all of your £100 today, it is £100 income for someone else. He has further incentive to spend it creating a chain of transactions.
In theory while this is a true mathematical loss, the increasing purchasing power helps you leverage your financial asset to get a return on your investment.
While it is a true loss, as you've determined, is not a cash cost, per se.
A cash cost would be a decrease in cash holdings. Inflation does not take your cash balance; it devalues it, so it is an accrued loss.
Central banks are extremely lazy in determining inflation, so the highest resolution available at a public level is monthly. In the United States, there is a small project that tries to calculate daily inflation rates and seems to do a decent job, but unless if you are a customer of a particular financial institution, you will suffer a lag. The small project refuses to make the data public in real time or even allow outside analysis.
In the UK, the Office for National Statistics is responsible for consumer inflation statistics. The methodology is not readily available, but considering the name, it is most likely an inferior Laspeyres index instead of the optimal Fisher index as it is in the US.
To calculate the accrued cost due to inflation, simply multiply the amount of money held by the price index value at the beginning of the time held and divide by the price index value at the end of the time held.
For example, to determine the amount of value lost since March 2014, multiply the money held by the price index value for March 2014 and divide by June 2014.
If inflation is at 2% per annum, in a year you would need £102 to buy equivalent goods to what you could buy today. So if you keep your money in a drawer the buying power of your £100 in a year will be only 100/102 = 98.039% of what it is currently.
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