- Nov 4, 2007
- Professional Status
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Inflation of your very own
Calculate your household's personal consumer price index
By Chuck Jaffe, MarketWatch
Last update: 7:31 p.m. EST Feb. 7, 2008
BOSTON (MarketWatch) -- At a financial seminar in Framingham, Mass., last fall, a woman named Geri stood up with a great question.
She wondered why the nation's inflation rate did not seem to apply to her. "They keep saying on television and in the paper," Geri said, "that the inflation rate is 3% or 4%, but it seems to me that prices on the things I pay are rising a lot faster than that. Is it possible that my inflation rate could be different from everybody else's?"
The short answer is yes and Geri's not alone. http://appraisersforum.com/redirector.php?url=http://www.marketwatch.com/pf/default.aspCheck out Personal Finance
When the Bureau of Labor Statistics provides inflation information in the form of the consumer price index, it is using a flawed system to represent the "average" consumer. And while the goods it prices are supposed to represent what that average consumer would spend money on, the truth is that no one spends money like the government figures.
Economist Kamran Afshar explains the problem in terms of two guys playing golf, where the first one tees off and hooks a shot into a bunker 20 yards short of the green and the second one slices a tee shot into the rough 20 yards behind the green.
"By the standards that are used to calculate inflation," Afshar says, "the average of those two shots is a hole in one. ... In fact, the average used to calculate inflation is very far off from the way most people spend their money."
Despite that, consumers base their financial planning on those national inflation numbers.
They could benefit tremendously by being able to figure out just how inflation hits them at home, so that someone like Geri can figure out if her spending pattern makes her vulnerable to higher inflation than her neighbors. Unfortunately, inflation statistics do not come with a personal rate calculator.
That's why Afshar made one.
At my request, Afshar, who runs the economic research firm Kamran Afshar Associates in Bethlehem, Pa., broke down the CPI into its components, creating the chance for individuals to see how inflation hit home in their own household in 2007.
Here's why individuals fall so far from the average
The consumer price index applies certain weights to each major sector of spending, so that it currently assumes that the average consumer spends 42.7% of income on housing costs (including insurance, utilities, furnishings, rent or mortgage, etc.), 6.3% on medical care, 17.2% on transportation, 15% on food, 3.1% on education and so on.
But a retiree whose house has been paid off for years, whose kids are a generation removed from college and whose appetite has started to wane, but who is facing serious medical concerns, will have an experience that is very different from the average.
Those medical-care costs face higher inflation -- just over 5% in the CPI -- than the housing costs (where inflation was 3% in 2007), so that senior is likely facing inflation that is above average.
That's a huge issue for someone living on a fixed income, particularly when that income stream was built around the CPI numbers for the "average person."
Conversely, a young couple with a few kids could be spending a fortune on food, a good amount on clothes -- where prices have actually been going down -- and on education. For them, the big issue might be if one spouse has a long drive, which could ratchet up transportation costs; the hike in gasoline prices has made it that transportation costs currently have the highest growth rates.
"You dig into the numbers and you realize that this may be average, but it doesn't actually apply to anyone," says Afshar. "And while inflation is important on an economic level, where it is most important is in your home, where you can then plan for it."
Afshar noted that there are several other factors that make it hard for the most prominent inflation measure to be accurate, most notably the fact that the prices are tied to a 1982-84 base. Imagine personal computers of that era -- big machines no longer available today -- and you'll have a quick handle on why there's a problem: There is no comparison you can make with today's computers and prices to those from 20 years ago.
There's also the "substitution" process; put simply, this holds that if the price of, say, carrots goes up, a consumer would simply substitute a different vegetable, like cucumbers, where the price is steady. That might work, unless the recipe calls for carrots or the kids hate cukes.
"I don't think the government wants people to know the numbers in their home ... it would just increase their frustration," says Jack Ablin, chief investment officer at Harris Private Bank.
"Having a better idea of how inflation hits you, however, would allow you to change your plans. A lot of retirees are relying on bonds to satisfy their living expenses, but when they really take a look at it, they may find that bonds aren't going to cut it. ... Better to know that now than when you just discover that you have a problem."
While Afshar used the most recently released numbers as the basis for the personal CPI calculator, he noted that consumers tend to run ahead or behind the national average consistently, up to the point where their habits -- and thus their spending patterns -- change. Thus, if the personal inflation rate for a household is 4.4 percent, the family is likely to remain roughly 0.3 percentage points above the national level for a time.
And while calculating your personal inflation rate is helpful for planning purposes, Afshar noted that CPI also tends to vary from one region to the next (think heating and cooling costs, for example), and that some regions are consistently more expensive or cheaper, which is ignored in the CPI numbers (and, thus, in the personal rate calculations).
"What would be best is if consumers had access to this information, so that they could use it to plan for real inflation," Afshar said, "but this information is the next best thing. If you don't know the real inflation rate in your home, then all you can rely on is the [government] numbers, and then hope that you are lucky enough so that your experience is somehow close to that average."
Calculate your personal CPI
Category% of your money spentInflation multiplierPercentage point contribution to total inflationFood 0.048Housing0.03Apparel-0.003Transportation0.083Medical care0.052Recreation0.008Education0.056Other expenses0.021Total100%
Here's how the calculation works for the government's CPI figure
CategoryDecember 2007 weighting in CPIInflation multiplierPercentage point contribution to total inflationFood 14.992%0.0480.72Housing42.691%0.031.281Apparel3.726%-0.003-0.011Transportation17.249%0.0831.432Medical care6.281%0.0520.327Recreation5.552%0.0080.044Education3.076%0.0560.172Other expenses6.433%0.0210.136Total100%4.10
Source: Kamran Afshar Associates, Bethlehem, Pa.
Chuck Jaffe is a senior MarketWatch columnist. His work appears in dozens of U.S. newspapers.
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