What Is Buying Power? (With Definition And Examples)

Updated 30 September 2022

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Investing often involves learning new terms and concepts. For instance, buying power is how much money a business or individual has available to invest in assets like stocks or bonds. If you have an interest in investing, it is beneficial to learn about this concept to help you optimise your investments. In this article, we define what buying power is, what the different types are and how to increase your own buying potential to make sound financial decisions.

What Is Buying Power?

Buying power, which some investors refer to as purchasing power, is how much money you have available to purchase financial options such as bonds and stocks. The money resides in a brokerage account so that the broker can execute trades based on an investor's instructions. Purchasing power includes true cash and margin power, which is the amount a broker wants to loan to an investor. For consumers, purchasing power is how much money they possess to purchase goods and services when they consider their regular expenses and income.

Why Is It Important To Understand Purchasing Power?

It is important to understand purchasing power because it can help you meet your financial goals. It can also help you determine how much money you have and ensure you invest within your capabilities. Learning about purchasing power is also helpful from a corporate perspective, as it can help a company remain in a good financial position while catering to its customers' budgets.

The Different Types Of Purchasing Power

Here are a few different types of purchasing power:

Margin purchasing power

Margin purchasing power is the amount of cash an individual has in a margin account. They can use this cash to invest in securities like stocks. A broker lends an investor money through a margin account, and the investor can use it to buy shares in various companies. A broker typically collects interest on all investments made from a margin account, so the investor forgoes some of their earnings. While an investor may pay more to receive stocks, they can also generate higher returns than if they were to invest what they had in pure cash.

With a margin account, you can double your purchasing power. You can typically borrow 50% of the amount you want to purchase. For example, imagine you have ₹4,00,000 in a margin account. A broker may lend you up to an additional ₹4,00,000, meaning that you can purchase up to ₹8,00,000 in stocks or other securities.

Trading purchasing power

Trading purchasing power is a type of buying power that originates from a margin account, but works a bit differently. This is the amount of money you have in your margin account to make trades during a specific period, which is often a single trading day. Trading purchasing power lets you leverage more capital, as you can often trade up to four times the amount of true cash you have in your margin account.

There are specific rules to follow when you use your trading purchasing power. For example, brokers typically require you to wait a day after a deposit before you execute trades. Brokers also typically require a minimum amount of maintenance margin.

Consumer purchasing power

Consumer purchasing power is what a consumer can afford to spend on non-essential services and goods. Disposable income is another word for consumer purchasing power, as it is the amount of money an individual has after they pay their taxes and bills. An individual can calculate their purchasing power for luxury goods and services after they pay for essentials like groceries, insurance and rent. The more purchasing power an individual has, the more excess money they earn at their job.

It is important for businesses to understand consumer purchasing power, as it can help them understand their target audiences. A company can conduct market research to determine the ideal price for the product or service they offer. This can ensure the company's customers can comfortably afford the offering while still ensuring it generates revenue.

An Example Of Purchasing Power

You can refine your understanding of purchasing power by considering this example:

An investor has ₹10,00,000 in a margin account. They want to purchase shares of a new environmental engineering firm they believe has a lot of potential for success in the future. The broker they want to use wants 50% of the initial margin to complete a trade. To determine their purchasing power, they perform a calculation. They do so by dividing the ₹10,00,000 they have in their margin account by 50% of the initial margin the broker requires. This calculation yields a result of ₹20,00,000, This means the investor can purchase ₹20,00,000 worth of shares in the environmental engineering firm.

How To Increase Your Purchasing Power

Here are some ways to increase your purchasing power so you can make more investments and increase your earnings:

1. Talk with a financial advisor

Talking with a financial advisor can help you better understand what purchasing power is and how it applies to your unique financial situation. The advisor can help you open financial accounts that help facilitate trades. They may also help you create financial goals and design a plan to realise them. You can also ask a financial advisor for guidance on what investments to make.

2. Lower your spending

One of the most effective ways to increase your purchasing power is to lower your spending. This creates more money that you can use to make investments. The easiest way to lower your spending is to create a budget and prioritise your expenses. Ensure that you allocate enough money for essentials like housing, food and transportation. Allocate money for non-essential expenses sparingly and take some time to consider what you need. If you share a financial situation with others like a spouse or family members, be sure to include them in this conversation.

This tip also works for non-individuals like businesses and larger corporations. A business can create a budget to classify essential expenses. It may also consider eliminating unnecessary costs like ineffective advertising methods. Some may even invest in more energy-efficient light bulbs and other appliances to lower long-term operating spending.

3. Find additional ways to generate income

As an individual, you may look for additional ways to generate income. Instead of relying solely on your full-time job, you may find a side or part-time job so you can increase your income. You may find another job that allows you to work evening shifts a couple of days a week. You may also earn money online by offering services like graphic design or freelance writing. This type of work helps you to establish your own hours and work whenever is convenient for you.

A business can also generate additional income and increase its disposable money. For example, a company can expand its service area to provide its offerings to more customers. It can also introduce a new product to fulfil a current need in the market. These methods are effective ways to generate more income that a company can use to make investments.

4. Increase your savings

If you already set aside money from each paycheque to put into a savings account, you may consider increasing this amount. Even increasing your savings from 10% to 15% can impact your buying power. You may consider increasing your savings in 1% intervals each week to make it easier to maintain and increase your savings rate. Consider tracking your savings in a spreadsheet so you know exactly how much money you contribute to your savings account. This can help you manage your goals and adjust when necessary.