What is your personal inflation rate? – Forbes Advisor

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Even when the official inflation rate was reduced in the dozen years following the Great Recession, families still felt the pain of rising costs.

Sure, a computer may have become more affordable, but tuition fees have skyrocketed. Cheaper clothes made back-to-school shopping easier, but rising health insurance premiums were hard to bear. A household’s job was to negotiate these roundabout costs in order to make ends meet.

This task only got worse over the past year as US inflation woke from its slumber. Prices are now rising at their highest rate in 40 years, and consumers have started noticing the trend.

There’s not much you can do to stem the rising tide of inflation, unless of course you’re Jerome Powell. Instead, now is the time to fully understand your personal inflation rate and employ strategies that will protect your bottom line.

What is Inflation?

Let’s start by defining how inflation works. When the price of a liter of milk or a gallon of gasoline to fill the car tank is higher today than it was in the past, that is inflation.

Although rising prices are a drag on your personal purchasing power, a little inflation is not bad for the economy. It’s the juice that compels us to save and invest, rather than just keeping our money parked up in cash.

Too much inflation, however, can be problematic. Right now, year-over-year prices are up 7.5% and wages aren’t growing fast enough to keep up: inflation-adjusted earnings are actually down 1, 7% in January compared to the previous year.

That’s why the Federal Reserve, whose job it is to maintain price stability, has announced that it will spend 2022 trying to bring the annual inflation rate closer to 2%.

A quick look at bond prices, which are sensitive to rate hikes and inflation, shows that traders believe the Fed will eventually get things under control. But a longer-term perspective can be helpful if you’re feeling particularly nervous about inflation.

“We tend to overweight current events,” said Christopher Sorrow, vice president of Dallas wealth management firm Probity Advisors. “From a planning perspective, we are experiencing runaway inflation for a short period of time.”

Why retirees need to plan for inflation

All Americans are affected by the current spasm of high inflation.

Gen Z may feel it most in the price of a used car or a night out on the town, but baby boomers are also in the crosshairs of inflation. A vivid example: the monthly premium of $70.10 for Medicare Part B in 2022 is 14.6% higher than the premium in 2021.

“Inflation is a tax on everyone,” said Craig J. Ferrantino, founder of Craig James Financial Services in Melville, NY. “Every household’s spending is different, but right now the price hike is so wide that everyone is affected.”

For American retirees, the biggest issue comes down to income. Workers have the opportunity to increase their income, especially in the current tight labor market. Retirees, on the other hand, usually have to stick to a fixed budget in order to avoid running out of money.

Social Security recipients receive a cost-of-living adjustment to their benefits, which helps reduce the effect of inflation. In 2022, Social Security benefits get a 5.9% COLA increase. But with inflation so high, that may not be enough for many to avoid cutting.

Even if headline inflation stabilizes from its current highs, it can still do a lot of damage to a retiree’s budget. An annual inflation rate of 3%, for example, would push a basket of goods that costs $100 today to over $200 in 25 years. And for anyone considering age 65 as a retirement age, living at least 25 years longer is a distinct possibility.

Interestingly, polls show that working people tend to be more fearful of inflation than current retirees. These heightened concerns could reflect the fact that rising prices are changing the calculation of what pre-retirees need to save.

“If you’ve set aside $1,000 a month for your retirement, the future purchasing power of that $1,000 could be much lower if inflation remains high,” Ferrantino said. “If that $1,000 doesn’t pay you as much later, you might want to consider saving more now.”

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How official inflation rates are calculated

Two calculations of inflation hold the attention of policy makers: the consumer price index (CPI) and the personal consumption expenditure index (PCE).

The CPI tracks the prices of about 80,000 goods and services in 75 urban areas across the country, basing prices on surveys of 6,000 households and more than 20,000 retail businesses.

The Bureau of Labor Statistics sorts data points into eight major groups: food and beverages, housing, clothing, transportation, medical care, recreation, education and communication, and other goods and services. CPI inflation calculation is a weighted average of these categories.

PCE also focuses on price by measuring the cost of a basket of goods, but is weighted by what businesses sell rather than what consumers buy. It also includes some costs that the CPI does not consider, such as health care paid for by employer-sponsored insurance plans, and treats changes in consumer behavior differently.

These differences explain why CPI rates tend to be higher than ECP rates. While the former recently recorded an annual rate of 7.5%, the latter stood at 6.1%.

You might also come across mention of the “basic” CPI and PCE. It is the code for a calculation that excludes food and energy. Although food and energy are basic necessities for households, their volatility can make it difficult to gauge the broader pace of inflation.

The Core PCE is the Federal Reserve’s preferred inflation. The Fed wants the core PCE to operate at an annual rate of around 2%. In January, it stood at 5.2%.

The importance of a personal inflation rate

Would you describe yourself as average? Although official inflation rates are important, they are not specific to your life and do not take into account all the factors that go into your personal spending.

At a minimum, where you live can be a big factor. Real estate prices are rising in cities like Nashville and Austin, making buying a home more expensive and raising property taxes.

So your personal inflation rate depends on how your household is doing. If you’re a remote worker, you probably won’t feel the commuter pain of significantly higher gas prices – a gallon of regular unleaded gas has risen more than 40% in the 12 months to January. Driving an EV? This is a good movement of inflation, because the price of KWH has not moved for a year.

Vegan? You have successfully avoided the worst of food inflation. The cost of fruits and vegetables increased by 5.6% on average in the 12 months ending in January, compared to a 12.2% increase in the prices of meat, poultry, fish and eggs.

How to calculate your personal inflation rate

Your personal inflation rate may be very different from the national averages that make the headlines. If you’re up for some Excel time, you can get a better idea of ​​your personal inflation rate by entering your costs into a spreadsheet and doing the math.

To keep it simple at first, you can work with the same categories used by the BLS: Food and Beverage, Housing, Clothing, Transportation, Medical Care, Recreation, Education and Communication, and Other Goods and Services). Pull out your debit card and credit card statements from a year ago and insert your itemized expenses into your spreadsheet.

Continue by adding up your costs in the BLS categories over the past month. Also be sure to account for large costs that you might pay less frequently, such as annual car and home insurance premiums, adding them up and dividing them by 12 to get a monthly cost.

To get an overall personal inflation rate, subtract your total monthly expenses from a year ago from your current monthly expenses. Then divide that amount by your monthly expenses from a year ago.

For example, if your expenses last month were $4,500 and a year ago they were $4,250, the difference is $250. Divide $250 by $4,250 and you get a personal inflation rate of 5.9%.

Ways to minimize the impact of inflation

If these calculations open your eyes, there are many ways to manage your personal inflation rate.

  • Cut the good ones to have. “We all have 10% that we can cut from our expenses,” Sorrow said. For example, you have to eat. While grocery shopping is one thing, eating out or ordering is another. Controlling your discretionary food expenses could help you reduce certain expenses.
  • Get a raise. If you haven’t gotten a raise yet, now is the time to put on your bargaining pants. Average wage growth bottomed out last spring and is now on the rise. You can also consider joining the Great Resignation. Data from the Atlanta Federal Reserve shows the recent median wage growth for people who changed jobs is 5.8%, compared to 4.7% for those who stay employed.
  • Delay Social Security. If you’re in your 60s, you’ve probably heard a lot about the benefits of delaying Social Security. Not only do you get a bigger benefit by waiting longer to claim benefits, but you end up getting more dollars which are increased each year by annual cost of living adjustments.
  • Take care of your business (and yourself). “An ounce of prevention now can help you avoid more costly problems later,” Sorrow said. Track maintenance for big-ticket items like your car and HVAC. Ditto for medical visits.
  • Plan ahead. Anticipate future junior college bills by setting aside money in a 529 plan and taking advantage of compound growth to combat tuition inflation.

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