Inflation, otherwise known as rising prices, can be scary.
If things keep going up and your salary doesn’t, inflation translates into a lower standard of living. That’s tough enough when you’re working and have the potential to make more money. When it gets truly frightening is when you’re retired, because then you no longer have the ability to keep up with rising prices.
Inflation has been picking up this year as the economy deals with pandemic-related high demand and supply-chain issues.
According to the Consumer Price Index (CPI), a basket of typical consumer purchases, overall inflation rose 6.2% from October 2020 to October 2021. That’s the biggest 12-month leap in more than 30 years.
- Energy prices increased 4.8% from September to October, and 30% over the past year.
- Used car and truck prices are up 2.5% for the month and 26.4% over the past year.
- New vehicle prices are up 1.4% for the month and 9.8% over the past year.
- Grocery prices are up 1% for the month and 5.4% over the past year.
And wages aren’t keeping up with rising prices. According to the U.S. Department of Labor, inflation-adjusted average hourly wages fell 0.5% from September to October.
But headline inflation, while scary, doesn’t tell the whole story. Because what really matters to you isn’t the overall U.S. inflation rate. It’s your personal inflation rate.
Let’s dig a little deeper.
Your personal inflation rate
While the national inflation may be interesting to talk about, other than academically, it doesn’t really matter. What matters is the rising prices that affect you.
By way of explanation, here’s an excerpt from a book I wrote years ago called “Money Made Simple.” It concerns how inflation is computed and, more important, how you can control and combat — at least to some extent — the impact rising prices have on your life. (Note: It has been updated to reflect how the Labor Department currently calculates and weights the CPI, and the percentages are rounded.)
Understanding the CPI
Prices for the goods and services used to calculate the CPI are collected in 75 urban areas throughout the country from about 22,000 retail and service establishments. There are dozens of products and services sampled, but they can be grouped loosely into eight categories. Here they are, along with the weighting that each category receives in determining the final overall inflation number:
- Food (14% of the CPI): This category includes all manners of food and drink, including restaurant meals, snacks and alcoholic beverages. A little more than half of this total comes from food and beverages consumed at home.
- Housing (42%): Most of this number comes from rent and homeowners’ equivalent expenses.
- Apparel (3%): Clothing, footwear, and jewelry and watches for men, women and children of all ages. Women’s stuff is a bigger chunk than men’s. (Astounding!)
- Transportation (17%): Little bit gas, little bit maintenance, little bit insurance, but mostly new and used car prices.
- Medical care (9%): Prescription drugs, medical equipment and supplies, physicians’ services, hospital services.
- Recreation (6%): TVs and related equipment and services, pets and pet products and services, sporting goods, toys, event admissions, books and newspapers.
- Education and communication (7%): College and school tuition and fees, child care, postage, phone and internet services.
- Other goods and services (3%): Tobacco and smoking products, personal care products and services, funeral expenses, stationery and gift wrap.
How does inflation affect you?
So how is the average person affected by changes in the Consumer Price Index? The fact is that there’s no such thing as an average person, but let’s have a look and see if we can draw some general conclusions.
Food: Nearly half of the food component of the CPI involves eating out, so if I were concerned about keeping that inflation cost down, I might eat a meal at home, then go out for dessert. There are dozens of ways to pay less at restaurants and at the grocery store.
Housing: When it comes to housing, a person who owns their own home, whether they’re retired or not, isn’t necessarily affected by inflation, unless maybe they’ve got an adjustable-rate mortgage. And this is by far the biggest category of the CPI.
In fact, I’d argue homeowners should really want this part of the index to skyrocket, since that would mean home prices are rising and their equity along with it. Ditto if our average person also happens to be a landlord.
Real estate, whether rental or owner-occupied, is the single biggest “savings account” most of us will ever have. So inflation in this category, as long as we already own some real estate, is more good than bad.
Apparel: Clothing isn’t a very big component of CPI, but one could easily keep their costs down by buying on sale, by buying used or by using my method of simply not buying at all. (Virtually everything I wear I’ve received as Christmas presents, and I wear it until it completely dissolves.)
Transportation: Next to housing, transportation is the largest component of what we regard as inflation, and most of that is made up of how cars escalate in price. Since buying a new car is pretty much a waste of money anyway, this part of the CPI could be addressed by buying used. As we just discovered, used-car prices are skyrocketing these days, too. But that’s likely a temporary phenomenon that will ease as supply-chain issues get resolved.
Gas prices are another component of transportation that is rising rapidly, but there are plenty of ways to save on gas. Insurance goes ever higher, but there are ways to reduce it, such as raising your deductibles and shopping for a better deal.
Medical care: Medical expenses are tough, but when our average person gets older, at least they’ll get a lot of help from Medicare. For the rest of us, there are ways to save. For example, shopping around to get the best rates, or using a high-deductible health insurance plan: I save a ton of money by using a $5,000 deductible policy combined with a health savings account.
Recreation: One of the largest components of recreation is TVs, which have been getting cheaper over time (even if the computer-chip shortage is currently increasing demand), and TV services. Streaming services and cable are going up in price for the most part, but there are now plenty of free streaming services and cable is hardly a necessity. I’d rather listen to a good free podcast myself.
Other goods and services: Most of this category concerns itself with toiletries (can you say “Costco”?), and services like funerals (note that cremations cost a fraction of burials) and legal services (software is certainly cheaper than a lawyer, among other ways to lower your legal bills).
So where am I going with all this? I’m not suggesting that inflation shouldn’t be a factor in your financial planning. It most definitely should be. But inflation depends largely on the type of discretionary spending you do. Therefore, you have a great deal of influence on how much influence inflation has on you.
There are inflation components that are pretty much out of your control. (While you can fight your property taxes, those types of expenses ultimately are tough to lower.) But the next time some news anchor tells you what the CPI did last month, don’t automatically assume that reflects what it did to you or your savings.