Do you know what your personal inflation rate was for 2004? Or why it's important to gauge how much it rose? The Consumer Price Index (CPI) measures the pace of U.S. inflation, by measuring the prices of consumer goods and services. Just recently, the federal government announced that consumer prices, as measured by the CPI, rose 3.3 percent in 2004-which is the highest increase since 2000.
But comparing your personal inflation rate to the national CPI is like comparing apples and oranges. The rates may not even be close.
The country's CPI is a measure calculated by the U.S. Bureau of Labor Statistics of the average change in prices paid by urban consumers for a fixed market basket of goods and services. The measure is taken monthly, then annualized for the previous 12 months. It is a widely used number.
Social Security uses it to adjust benefit payments to retirees, it's a bargaining chip in wage negotiations, and the Federal Reserve uses it as one of many indicators in deciding whether to raise or lower interest rates.
But what does the national CPI say about your personal cost of living, if anything?
Let's look at three major expenses for many families: housing, medical care, and college. Some critics say the national CPI underestimates the impact of these expenses. But beyond that, your personal CPI may differ dramatically from the national CPI depending on where you live and how much these three expenses figure into your cost of living.
The housing component of the national CPI average is based primarily on changes in rents. This number factors out equity gains for homes, and came in a mere 2.6 percent in 2004. So for renters, the national CPI might be closer to their personal CPI, but not for someone buying a home.
What about health care costs? While the national CPI's medical-care component rose only 4.2 percent in 2004, the reality for many people is that the cost of medical care rose dramatically. This is especially true for older people who typically spend much more on health care than the average person.
Families with children in college also will have a different'typically higher'personal CPI than families who don't have children in college. The 'education and communication' component of the national CPI showed a mere 1.5 percent increase. Yet the average increase for the cost of tuition for in-state students at four-year public colleges for the 2004-2005 school year rose 10.5 percent, according to the College Board. That came on the heels of a 13 percent rise the year before.
All of this illustrates that your personal consumer price index may be quite different from the national CPI. In some cases, personal CPIs may be lower than the national average, but for others it will be higher. Why is this important information to know?
Herb White is a Registered Representative of and offers securities through Woodbury Financial Services, Inc. Member NASD, SIPC
- It is helpful to factor in your personal inflation rate when planning for future retirement needs and budgeting.
- Knowing your personal CPI helps you trim your budget in high inflation areas.
- Your CPI will help you keep a diversified portfolio with investments that have a history of outpacing the rate of inflation.