Consumer price index doesn't address personal costs

But do you know what your personal inflation rate was for 2004, why it’s important to gauge how much it rose and what you can do about it?

Your personal CPI and the national CPI are not likely the same. They might not even be close. As the U.S. Bureau of Labor Statistics notes, the national CPI “seldom mirrors a particular consumer’s experience.”

CPI debate

The CPI is a measure calculated by the 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.

There’s been much debate about how the CPI is calculated and whether it accurately reflects true price changes. Regardless, it’s 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 the CPI as one of many indicators in deciding whether to raise or lower interest rates.

But the national CPI probably doesn’t say much about your personal cost of living.

CPI factors

Take, for example, three major expenses for many families: housing, medical care and college.

Some critics say that the national CPI underestimates the impact of these expenses. Beyond that, your personal CPI might differ dramatically from the national CPI depending on where you live and how much these three costs figure into your cost of living.

The housing component of the national CPI average, which is based primarily on changes in rents and which factors out equity gains for homes, came in at a mere 2.6 percent. For renters, the national CPI might be closer to their personal CPI, but not for someone buying a home.

According to the National Association of Realtors, the national median existing-home price rose 8.8 percent in 2004. And in nearly half of 129 metropolitan areas surveyed, home prices rose in double-digit figures, including a 47 percent increase in Las Vegas and better than 30 percent increases in certain markets in California and Florida.

But in some regions, house prices barely budged. Even within a specific market, price increases can vary depending on the price range or the type of house you’re looking for.

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 more. 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 – and 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 2004-05 school year rose 10.5 percent, according to the College Board. That came on the heels of a 13 percent increase the year before.

All of this illustrates that your personal consumer price index might be quite different from the national CPI, and you need to plan your finances accordingly. In some cases, personal CPIs might be lower than the national average, but for others, it will be higher.

Managing your CPIM

There are some steps you can take to control your own CPI.

First, plan for it. When calculating your budget or future retirement needs, be sure to take into account your inflation rate.

Second, trim high inflation areas. You might have the ability to trim expenses in some areas. If necessary, you can send your child to a less expensive college, or you can buy a less expensive home. It’s more difficult to trim some expenses, such as medical care, but you can find savings there, too.

Third, review your investments. A diversified portfolio can go a long way toward helping combat inflation. Assuming that you have ample investment time ahead – say at least five to 10 years – you should consider investments that have a history of outpacing the rate of inflation, such as stocks and investment real estate.

This article was produced by the Financial Planning Association and provided by William O. Woody, CLU, ChFC, CFP, of Stovall Woody Associates.

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