Inflation. Deflation. Hyperinflation. It’s all people seem to talk about these days. I’m always reading that you should always consider your investment returns after inflation. But what is inflation? Most of the time, they are talking about the Consumer Price Index for Urban Consumers (CPI-U) published monthly by the Bureau of Labor Statistics. This is based on the price of a theoretical basket of goods. Here are the components of the CPI, made into a nice pie chart by dshort.com from this recent BLS CPI report.
However, common sense tells us that we do not all share the same inflation rate. A long-distance trucker will be much more sensitive to the price of gas than a couple living in Manhattan. A grandmother who has owned her home since 1940 and doesn’t plan on moving doesn’t notice if rents are rising 3% or 6% a year. The CPI could have very little correlation to your personal inflation rate.
In addition, it’s possible to manage our own personal inflation rates by changing our behavior or making some upfront investments. Let’s take a look at the largest components of the CPI.
Housing (42%)
This category includes the cost of rent (or owner’s equivalent cost) as well as utilities like gas and electricity. The most obvious way to deal with inflation is to own a house, either directly or via mortgage. With a 30-year fixed mortgage, your monthly payment is going to stay the same, and your total housing payment is only going to vary a bit as your insurance and property taxes go up. My neighbor used to have a mortgage of $300 a month.
As for utilities, a solution I plan to install is solar photovoltaic (PV)panels. In most states, you can sell back the electricity you generate with solar panels throughout the day, so that it cancels out your entire electricity bill. With a large enough system, you will never have a power bill again. Here is a helpful PDF consumer’s guide on solar systems from the Department of Energy.
The large upfront cost can be defrayed with federal and state tax credits, and the panels come with (about) a 25-year warranty. Other parts, like the inverter, come with a 10-year warranty. If you have the space you could also install a windmill, or contract electricity from other sources.
If you live in an especially hot/cold climate and much of your expense is cooling/heating, a very important area is insulation.
Transportation (17%)
This category includes the cost of vehicles, public transportation, and fuel. I plan on owning all my cars for at 10 years each, so even though it will catch up to me eventually, the annualized cost should remain reasonable. Avoiding the hit of depreciation during the early years, either buy buying used or holding for a long time, is important.
As for fuel, again I plan on using my solar panels to create electricity for my plug-in electric vehicle. Range is currently an issue, but as battery technology improves, I expect that it will be feasible for most households to own at least one electric vehicle.
Food & Beverages (15%)
This category includes food at home, dining out, and also alcohol. Why not grow some of your own food? We are starting to dabble in square-foot gardening, which involves planting small, efficient gardens that use minimal water, pesticides, and labor. Dining out is one of those expenses that is almost all for pleasure and convenience, so if it becomes hurtful then we’ll cut back. I’ve already been cutting back on the alcohol for waistline reasons.
Education & Communication (6%)
I’m not sure why these two are lumped together, but I really don’t see communication costs rising very much in the future. It would appear that data transfer is only going to get faster and cheaper. On the other hand, education costs continue to skyrocket. (Okay, now I see why they are together… sneaky) Even though this is only 6% of the CPI, if you have kids then tuition prices are likely a huge concern. If you don’t have kids (and are done with school), then you don’t care at all.
There are still some limited opportunities for prepaid college tuition out there, which are worth exploring if you accept the penalties for not following their restrictions. An example is the Florida Prepaid college plan.
Any other ideas for controlling your personal inflation rate?
The Best Credit Card Bonus Offers – October 2024
Big List of Free Stocks from Brokerage Apps
Best Interest Rates on Cash - October 2024
Free Credit Scores x 3 + Free Credit Monitoring
Best No Fee 0% APR Balance Transfer Offers
Little-Known Cellular Data Plans That Can Save Big Money
How To Haggle Your Cable or Direct TV Bill
Big List of Free Consumer Data Reports (Credit, Rent, Work)
If and when we build our dream house I am planning to install a ground-source heat pump, which is similar to a regular heat pump except that it exchanges heat through pipes under the ground rather than with the air. Since ground temperatures are very stable around 68 degrees this kind of system uses very little electricity to bump the temperature up in the winter and provides very cheap A/C in the summer, plus generates hot water in the summer at a very low cost. The system costs more upfront then a conventional heat pump but there are incentives similar to those for installing solar panels that can defray the cost.
I own some rental real estate, and plan on expanding my holdings. Right now it’s small fries, but that rental income is just about paying my entire mortgage. My mortgage won’t go up, but the rents will. Bring on the rental inflation!
P.S. Probably the best CPI illustration I’ve ever seen. Very granular, and gives you the weighting of every individual product/service category — e.g. one component of housing is “clocks, lamps, and decorations”, which makes up 0.3% of the CPI bucket. This is an old graphic (2008), but still interesting, I think.
http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html
All of the discussions on inflation and investing come back to how it effects your capacity to live off of your investments. In this sense, you can simply track your “personal inflation” by tracking your overall core budget growth (ie, excluding savings) each year. This can bring to light lifestyle inflation as well as elect/food/lodging inflation. Set a max target each year and make sure you dont go over it, even if you get a pay raise. Put the excess to savings vs spending.
Predicting inflation/retirement projections off the govt CPI can be very misleading though the press/planners always focuses on it. All economics, like politics, is local.
Solar will not solve everything! Geeze
I looked into getting solar on my house,
1.its really expensive even with the credits.
2. Even if I covered my whole house in solar and I live in Phoenix (no clouds all sun 90% of the year) I would only generate about 30% of my electricity so I really doubt that these solar panels are going to completely offset your electricity.
3.Even if they did the utility company could change their policy on credits.
4.I really doubt you will have enough left over for your car!
I like this article as I never thought about my personal inflation but these recommendations need to be better thought out.
Great tips, I’m also considering to move to a more energy-efficient house with a PV system on the roof. And if the neighbourhood is close to my work location, I’ll buy an electric car and charge overnight. The cost of the car plus the PV system will surely be high, but my calculations suggest It will pay off in the long term for sure!
And about the bundling of education and communication – It sure is weird, another little statistical lie to make the numbers look better?
Is this against income or net income?
Agree with Greg about rentals. The income in cash v. the carryover for passive activity losses is quite nice.
Home and health insurance are getting like 10% inflation every year…
This is interesting. Not much I can do to control inflation of property taxes and things like that as well as food, but gas costs can be partially compensated for by walking & biking more. I plan on using the bicycle more in the warmer months!
I think home/cars are the biggies. Over the years, I see these are the areas we prosper compared to others.
Then again, I haven’t figured out what to do with health insurance inflation (where we once shelled out $100/month, it is now more like $1000/month, insuring a family – 10% – 30% increase every single year). But is good insurance and has been extremely worthwhile, so we keep it. We’d be bankrupt without it, due to random health issues in our youth.
For other insurances, lock low rates while young (life, disability). Our home insurance may vary the most, but it went down this year for us. Auto insurance is fine – we drive very carefully to keep our low rates.
Buying an energy efficient house (VERY frugal), has been a good hedge for rising utility costs. Thing is we didn’t pay a premium for the house, but the energy bills are rock bottom. We don’t get hit much with rising rates, accordingly.
@Andy – Good tip!
@Greg – I like the rental view. Thanks for the graph link. I remember seeing it before, but since forgot about it. I agree, it does a good just illustrating the relatively contributions.
@Jacob – Haha, I know I’m gung-ho on solar right now. I just got some contractor estimates and I can easily get enough panels to cover 100% of my energy usage. One factor is how expensive electricity is in your area, that affects how fast you ‘earn” your investment back.
@Thad – Good viewpoint, it doesn’t necessarily matter if gas goes up 10% if we simply spend more money on consumer gadgets – spending is spending.
@Invest It Wisely – Bikes are good, also living closer to things and driving less is kind of an investment.
@Alexandria – I have no idea what to do about health insurance, it seems so dependent on government policies as well.
I should have written more about insulation as well, I guess it’s obvious I live in a warmer part of the US. Good windows and other insulation is very important when you’re paying so much for heating.
Solar may cover 100% of your electricity is your electricity usage isn’t that high. In some parts of the country you may have relatively low electric usage since you use something else for heat and have little need for AC. In Phoenix you may have a lot higher AC usage and thats all electricity. In a cold climate you have zero AC usage and may use gas or oil for all your heat.
I definitely plan on driving less and eating out less in 2011. Hopefully that can save me some money. I’m also hoping to buy a home in 2011 so anything I can save in remodeling would be great.
And this is why the CPI is such a joke. Hellooooo, what about
health care? 6.5 %? If I were to retire tomorrow, I’d pay $1000.00
per month, for a HIGH DEDUCTIBLE policy. If I’m lucky.
(some years back, a doctor heard a heart murmur) But even people
without a preexisting condition will get close to that.
$1000 a month for health insurance? I pay under $160 a month and it hasn’t changed much in the past few years. Perhaps you should shop around?
I am self employed at ae 61 and pay about $400/mo for health insurance with a $6K deductible. Every year since 2006 my premium has increased at least 25%. Unless you are insured through an employer, health insurance becomes very expensive for the middle aged and for seniors, until Medicare. Most people have no idea how expensive it is, especially for those who have any kind of pre-existing condition.
I’ll never understand how anyone can stay something so stupid like ‘inflation is good’.
Right now, thanks to the Federal Reserve, many things are increasing, but wages are stagnant because of the high unemployment. More warm bodies drives down the costs of labor. Even worse, those lower wages don’t buy what they did even 10 years ago. I’m better off than most, but I’ve barely kept up with the lied about CPI.
I would put together a small solar system for running a computer or whole house fan or charging, but you have to expend some serious money for even a couple of kilowatts. I thought about a wind/solar 2kw system for a relative’s rural area, but by the time you buy the wind generator, panels, and a good power inverter (don’t cheap this), you still have not even included labor.
I think home/cars are the biggies. Over the years, I see these are the areas we prosper compared to others.
Then again, I haven’t figured out what to do with health insurance inflation (where we once shelled out $100/month, it is now more like $1000/month, insuring a family – 10% – 30% increase every single year).