Silent Inflation Is Destroying Your Net Worth

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Last updated on July 23, 2019 Comments: 16

According to the government’s figures, inflation was a modest 2.7% over the twelve months ending in March. The Consumer Price Index (CPI) is the Bureau of Labor Statistics’ popular measure of economic changes affecting typical consumers in the United States. It’s a figure we often compare to after-tax savings interest rates, reminding us that our funds locked safely away in FDIC-insured banks are losing real value every day. Even supposed high-yield savings accounts are no match for the government’s figures.

This comparison doesn’t make sense on an individual level because the CPI is not an individual measure. Overall, we can look at the economy and see that an increased number of people who are saving and the increase in savings account balances coinciding with a bigger spread between the interest rate earned after tax and the CPI can be bad, but any individual cannot use this information to make financial decisions.

The Saver’s Dilemma is that as a whole, we tend to save more when it’s less financially advantageous, avoid debt when it’s cheap, and spend recklessly when we would be rewarded for saving. Furthermore, the government’s numbers hide the reality that individuals deal with. Personal rates of inflation are often much higher than official statistics, due partly to limitations in the calculation and partly to individual spending patterns. It helps to remember than savings accounts are primarily for cash that you need within a year, including an emergency fund, so the interest rate should be mostly irrelevant.

Here’s a rundown of some of the flaws or limitations of the Consumer Price Index:

  • CPI focuses on urban consumers. Rural consumers may have different experiences that are not reflected in the calculation. This may help to hide price increases that millions of Americans experience due to rural reliance on transportation, for example.
  • The components of the CPI, such as food and energy, are weighted. The price of food and beverages comprises 14.792% of the CPI while medical care is weighted 6.627%. These percentages might not reflect any individual’s spending patterns.
  • The sample ages differently than any individual. Forgetting the concept of emotional age, individuals age linearly. Each year you will be one year older than the last. The change in your income, for the most part, increases with your age. The age of a population sample does not progress in a straight line. For example, baby booms can skew the average age downward from one year to the next, when those babies are old enough to become part of the sample.
  • Personal desires become needs. Over time, the middle class has become better off. It was once a luxury to own a television sets; now households often own two or three high-definition TVs and several computers. The standard of living has increased and what it means to “get by” has changed. This is an overall observation, but it might apply to you without being reflected in the CPI.

These limitations make it difficult for you to calculate your real return. Convention calls for subtracting the inflation rate from your investment return to determine your “real” rate of return. That may be fine for comparing your performance with other possible investments, but it doesn’t provide a true understanding of how your purchasing power has changed. Your purchasing power depends entirely on what you purchase.

Look at your real expenses. This is easy to do if you track your spending. How much do your expenses change from one year to the next? Your personal rate of inflation may be much higher than the CPI for a number of reasons:

  • You have more money to spend.
  • Your tastes change and you want better quality products.
  • You were hit with major one-time expenses.
  • Your children are getting older.

While you may be getting more for your money in some areas, you’re not in others. Food prices may increase, but if you have three mouths to feed this year when a year ago you had only two, the effect of the price increase will hit harder. If your company moves to a new location twice as far from your home as last year, the increase of the price of fuel is more damaging to your finances than the CPI would indicate. While your $2,000 computer today will be more powerful than a $2,000 computer last year, it still serves the same functions.

Silent inflation — the increase of the cost of your particular mix of expenses and the change in your spending behavior — is what is destroying your net worth. There’s no investment that sufficiently fights this type of inflation. There are two proven strategies:

  1. Spend less money. Consciously controlling your expenses and cutting back on certain expenditures can reverse the effect of your personal inflation. Obviously not a popular approach except among the terminally frugal, almost everyone can find ways to shave the top off their expenses. David Bach, who created the Latte Factor, talked with Consumerism Commentary about options for individuals who already cut their expenses as much as possible but still wanted to save their finances.
  2. Earn more money. You can only cut your expenses to a point — the point at which you are spending only on necessities for life. Once you reach that point, earning more is the only option. Even when you have more to cut, you can benefit from earning more. Although a penny earned is not worth as much after tax as a penny saved, the possibilities for increasing income are limited only by your time and your willingness to learn new skills and take on new projects.

Often, people suggest investing in assets that produce revenue, like rental properties, as a way to put yourself on the better side of inflation. Aside from the risk involved with any type of investment, the benefit might not be so great. If you can increase the rent with the increase in the CPI, for example, you will increase revenue to the landlord, but the landlord’s expenses will also increase. Raising rents may not be pure profit.

Calculate your personal rate of inflation by comparing expenses from the past 12 months to your expenses from the 12 months prior. Did the expenses increase? If so, are you living better off than you were in the previous year or does the increase not reflect any substantial changes in your lifestyle?

Bureau of Labor Statistics

Article comments

Anonymous says:

My thought is CEECEE has wrapped it up with her comment. Covered health care will someday soon be only for the wealthy.

Anonymous says:

I don’t really care about the CPI numbers or data. Looking at this i’ve tried to determine what my personal inflation rate is. Using the same proportions as the government i’ve determined that my personal rate is in the negative 1.2% range. Gas is up. Medical is down. Food is mostly even (down slightly). This number sounds right. I’m making slightly less but still am managing to pay off my debt.

Anonymous says:

The cost of items we need everyday are definitely rising faster than being reported. This is definitely a problem for every consumer in the short-term. The real long term problem is the Savings Dilemna which is forcing investors out further on the risk curve than they may desire. If they invest with maximum safety they make next to nothing but inflation eats away at their purchasing power everyday. Investors have tough choices because if they take little risk they are guaranteed to lose purchasing power and if they take additional risk they may not feel comfortable losing a large portion of their portfolio. ‘
The inflation dilemna you are presenting has make asset allocation even more critical to successful investing. In order to keep up with inflation and keep risk within an investor’s risk tolerance they must put together a well diversified portfolio with particular attention to asset allocation.
Ken Faulkenberry

Anonymous says:

At least in my opinion what only matters is what your personal inflation rate. While the CPI numbers might be off (why they are off is a whole other debate), it’s overall accurate.

In fact MIT has The Billion Prices Project which measures inflation via prices on the Internet and tracked pretty close to LBS’s CPI.

Anonymous says:

The government is WAY behind in their calculation of c.p.i., imho.
Whether it is Medicare premiums, or commercial health insurance premiums,
(or paying health costs without insurance)
we are paying for the health costs of the less fortunate. Even if your (current)
premiums are around 5% of your personal c.p.i., it’s my belief that your
lower pay as your employer has to pay premiums inflates your health expenses
way past 5% of your total budget.
It is in the government’s interest to understate the c.p.i., for public relations
purposes, and to reduce inflation indexed payments for i-bonds, Social
Security, etc…..
(I’m still very fortunate, over all, but some doctors, lawyers, bureaucrats, and thieves
are working hard to cut into my (our) good fortune).

Anonymous says:

I’m a doctor and have never worked hard to cut into your (our) good fortune. As a matter of fact, I spent last night working hard to keep people alive. The times, they are a-changing when you sweep doctors into the bin with the bureaucrats and thieves.

Anonymous says:

There is nothing wrong, hidden or flawed with the CPI figures. CPI is a national average over all consumer prices. If people think that such a national average figure should apply EXACTLY to them as an individual then they are just confused and mistaken. Its like hearing that the median cost of a home in the USA is $153k and then declaring that number is “wrong” because your own home cost more or less.

Anonymous says:

flexo, is there a reason why medical expenses comprise only 6% of CPI while food is 14%? IMHO, medical costs have to be much higher especially since those of us who are employed will have our health insurance premiums skyrocket. I’d like to know what percentage of the CPI accounts for gasoline.

Anonymous says:

Yes, the reason is that about 6% is the average portion of the average consumer’s expenditures devoted to medical expenses. Mine is much less than 6%, so it doesn’t sound unreasonable to me.

As for gas, the answer is about 5%.

Everything you ever wanted to know about the CPI and more:

Anonymous says:

i understand where these numbers are coming from, but, man, it is just so hard for me to imagine that the number for medical expenses is not higher. while yours may be lower, as is mine, it would just seem that with all the people getting older and living longer, that the number would be much higher.

Anonymous says:

Inflation hits everyone differently. The people who tend to feel higher gas prices and food costs the most are also generally the people poorest equipped to handle higher costs. Its the rainy day scenario, but if you haven’t prepared for it, you are almost certainly in trouble.

Anonymous says:

Surprisingly, I’m see the worst increase in housing. It seems like in my area, when the recession hit prices went down beyond what was corrective due to panic. Home sale prices began going up after a year and the rental market has been going up in the past 6 months-1 year. I just had a major increase to my rent and I am shocked how much cheaper my rent still is than other apartments in the area!

Anonymous says:

Although I am paying more for gas and food thanks to the increase in oil, I am earning more this year. We made modest changes to food and driving to lower the effects of inflation. The increase in my investment portfolio is much higher than inflation, so I am happy.

Anonymous says:

Compute your individual inflation rate and fight inflation where you can. Changing product selection, using timed-buying or just cutting back can all keep the income statement positive. For those of us who lived through the Jimmy Carter economy, we know how to do it. Although for those of us who were savers at the time, it really paid off. Look at all the alternatives. My wife and I shop at COSTCO once a month to get bargains on paper products,coffee, etc. Coffee is a great example; since I have about five months’ worth of coffee on-hand, when I sat down to read Consumerism Commentary today I had a $.28 cup of coffee instead of a $.41 cent coffee had I just bought the can of coffee yesterday. Delaying the impact of inflation can work too.

Anonymous says:

I personally bump up my exposure to investments with a higher present income as well as precious metals companies that pay dividends.

I mitigate this additional risk exposure with investments in inflation protected bonds.

I agree completely with your take-down of the dis-functional variables behind the CPI.

Who remembers the days of high-yield accounts that actually had yields?!

Anonymous says:

Since so many bankruptcies are a result of medical expenses, I think that these should have a greater place in this scheme. My insurance premium is way over what I spend on food!