What is your “personal inflation rate”?
I’ve been reading a lot about inflation lately and the potential impact it can have on families. I’ve also received questions from clients about future inflation expectations. Some of the current thoughts on this issue relate to the “personal inflation rate”. In other words: How does the current inflationary environment affect individuals?
This makes sense to me, because everyone spends their money differently. Budgets tend to have the greatest impact in areas where you most need to spend money, or the nondiscretionary portion of your budget. Of course, if high levels of inflation persist, the possibility of inflation affecting the discretionary portion of your budget may become a problem as well.
Breaking it down, nondiscretionary expenses are things like mortgage or rent payments, insurance premiums, car payments, food, energy use, water, tuition, etc. Discretionary expenses will likely include personal travel, dining out, club dues, alcohol consumption, new cars, new homes, etc. — all things consumers can adjust their spending habits to account for their family budget sensitivity to inflation.
My Personal Inflation Calculator
In order to try to work through this on my own, and to provide guidance to our clients who are concerned about the impact of inflation on their planning, I have created a Personal Inflation Calculator using the latest numbers from the Bureau of Labor Statistics. If you’ve never looked at the monthly reports from BLS, they are very comprehensive and cover a few common budget items. It’s also broken down into “seasonally adjusted” and “unadjusted” inflation rates for each component.
Seasonally adjusted numbers take into account normal inflationary increases due to seasonal adjustments and remove their effect from the calculation. For example, gas prices tend to be higher in the holiday period and during the summer holiday travel period. Prices for other items may go up or down during the winter holidays. Unadjusted rates Just look at the raw numbers and the price increases from period to period.
Depending on the current economic environment, and the rapid pace of inflation, I focus only on the unadjusted inflation numbers from May 21 to May 22. Seasonally adjusted estimates are likely to vary in some ways, but the unadjusted rate should give us a worst-case scenario. As stated in a BLS May report, “Unadjusted data is of fundamental importance to consumers who are interested in the prices they are actually paying.”
The worksheet you created takes some of the most common categories of household expenses and allows us to enter annual amounts for those categories. An inflation factor is applied to each item, which results in an estimated price for that item or service in the current period. Then we sum all these budget lines and develop a personal inflation rate from the difference. I think this can be more informative if we include budget items based on previous year’s estimates, to show how prices have changed in real time. I’ve also added some items for occasional purchases, like a new home or vacation home, or a new car, so we can look at the effect of inflation on those specific items.
The end result is that we can adjust the inflation rate for a specific individual or family, as opposed to the overall rate that is usually quoted for the entire economy. For example, if someone has a very low-cost lifestyle but depends on fuel oil to heat their home, they will have a higher personal inflation rate than someone who heats their home with electricity.
I approached my test analysis with the assumption that we’ll start with budget estimates for 2021 and try to predict how a typical family budget will be affected in 2022. Some interesting observations have emerged.
In Case #1, it was considered a family of four with two young children and an annual household budget of $108,400. This includes things like (annual amounts for 2021):
- Mortgage: $18,000
- Auto loans: $7,200
- Credit Card Payments: $2000
- Property tax: $4,000
- Grocery: $10,000
- Gasoline: $3,600
- Natural gas: $1,200
- Electricity: $1800
- Air tickets: $3000
- Living away from home: $1,500
- Eating out: $6000
- Pet food: $1,200
- Veterinary costs: $600
- Cordless phone services: $1,400
- Cable TV: $1800
By my calculation, based on their budgeted expenses, this family has an inflation rate of 8.53%, putting their 2022 budget at $117,650. This family may have to take steps to reduce this expected increase, and it is likely that they are already feeling it.
Your inflation rate will vary
When determining your personal inflation rate, be aware that some budget items will not increase for the foreseeable future, such as fixed debt payments (mortgage, car loan, etc.). However, credit card interest rates are sure to go up – along with the general rise in interest rates associated with inflation, so will many other things, such as food, travel, gasoline, and utilities.
In fact, the costs of some budget items, such as “elementary and secondary school food” and “computers, software and smartphones”, are expected to fall.
The largest increases (unadjusted) were in the following areas:
- Housing prices: +20%
- Rent: + 5.2%
- New Car Prices: +12.6%
- Used car prices: +16.10%
- Gasoline: +48.70%
- Fuel oil: +106.7%
- Electricity: +12%
- Natural gas: +30.2%
- Flight tickets: +37.8%
- Living away from home: +19.3%
- Eating out: +9%
- Food / Grocery: +11.9%
- Permanent Preferred Health Insurance: +13.8%
As you can see, there are some discretionary items in this list, and some non-discretionary items. Therefore, depending on your spending plans, your personal inflation rate will vary. For example, if our hypothetical family of four decided last year that they would buy a new home this year, at a cost of about $300,000, their personal inflation rate is close to 15.03% on a seasonally adjusted basis and 16.96% on an unadjusted basis (of course , if they are renters, and by buying their home they manage to reduce their annual expenses in the process, they have just lowered their personal inflation).
If they had planned to buy a new car worth $35,000 this year, the personal inflation rate would rise to 9.53% on an unadjusted basis. If our family of four had plans for more inclusive family vacations this year, and we increased their airfares to $7,000 and their stay away from home to $5,000, their inflation rate soared to that 9.87% without buying a new home or car. .
Some fast food:
- Depending on your budget’s sensitivity to items that exhibit higher inflation rates, you may want to consider delaying the purchase of these items, assuming they are discretionary in nature, such as homes, cars, and increased travel.
- Take steps to pay off adjustable rate debt, such as credit cards.
- Consider making your home more energy efficient (although this may expose you to higher inflationary costs from remodeling companies), and if you start seeing higher utility bills, consider shopping for energy providers.
- Renting versus buying a home is a tough challenge right now, because even as rents increase, mortgage rates and home prices are also rising. However, given that the expected rise in rents is +5.2% and the annual increase in house prices nationwide was +20% in February, it will likely delay home buying until home prices have fallen to a more reasonable level.
- If you have an adjustable mortgage, meet with your advisor to determine if this should be refinanced at a fixed rate.
- The purchase of a vacation or a second home may be delayed until this situation resolves itself.
- The cost of groceries goes up at a slightly higher rate than the costs of eating out. This may give you pause when you think about cooking all your meals at home. However, perhaps consider cutting back on the more expensive menu items, as well as the more expensive drinks.
In conclusion, the drumbeat of frightening inflation numbers worries everyone. However, if you take a few minutes to reconsider how you spend your money and calculate your personal inflation rate, you may come up with some solutions to put your mind at ease.
You can get a copy of my personal inflation calculator here: https://info.artifexfinancial.com/personal-inflation-rate.
Founding Partner, Artifex Financial Group
Doug Kinsey is a partner at Artifex Financial Group, a fee-only financial planning and investment management firm in Dayton, Ohio. Doug has over 25 years of experience in the financial services industry and has been a CFP® certified since 1999. Additionally, he is a Chartered Investment Trustee (AIF®) as well as a Chartered Investment Management Analyst. He received his undergraduate degree from Ohio State University and a master’s degree in management from Harvard University.