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What’s Your Personal Inflation Rate?


Recently, the Federal Reserve downgraded the outlook for the U.S. economy. Following this downgrade, Ben Bernanke then announced the beginning of Operation Twist, a $400 billion program to “twist” short term bonds into debt with longer maturities. This move has a debate started up again about what the effects will be. Some think that, as stimulus measures go, this is a pretty weak attempt that does little to really kick off some serious quantitative easing. (Of course, the Fed insists that Operation Twist doesn’t constitute quantitative easing, and that QE3 isn’t exactly in the works.) Others, though, wish that the FOMC would stop trying to force the economy into certain measures, and just let market forces do their thing.

With this next round of economic intervention, once again the topic is heading back toward inflation. The point of economic stimulus is to try and spur economic growth – and encourage an “acceptable” amount of inflation. For savers, this means that interest rates are likely to remain low for quite some time. Indeed, expectations are that a low rate environment will prevail until 2013. Theoretically, inflation will be low during that time, so there won’t be any need to raise interest rates.

However low the “official” inflation rate may be, though, it may not be your own personal experience. Indeed, many are concerned that the measures the government uses to measure inflation might actually underestimate it. And, of course, there are those that argue that all the recent economic stimulus is likely to lead to hyperinflation in the economy. Instead of just tracking what is happening with inflation in the economy, you can also look at your own personal inflation rate, and figure out which areas are most likely to affect you.

Why Your Rate of Inflation Differs from the Official Rate

The official inflation rate is based on a basket of prices, and weights different areas according to what the “average” consumer pays. Of course, your individual situation means that your personal inflation rate will be different than an average of what is happening across the country. So, if you want to get a better idea of what is happening in your own personal economy, you can track your own personal inflation rate.

You can start by looking at the consumer price index components the government considers (energy is actually part of transportation and housing costs, and doesn’t have its own category, although the government puts out a separate “energy index” to track energy costs):

CPI Components

Take a look at the different categories of the CPI, and see how they compare to your actual spending. If you have personal finance software, it’s fairly easy to create a pie chart that can break it down in a report, showing you what percentage of your income goes to different categories. Compare the two, and see where there might be differences. Perhaps you are in great physical health, and your medical costs are only 3% of your income. However, you might have a long commute to work, and end up paying 20% of your income for transportation costs.

You can go all the way down the list and figure out where you might match up with the “average,” and where you might spend more or less. Over time, you can track your own spending to see trends in your personal finances, and compare them to the inflation rate reported by officials.

This exercise can help you see how your personal spending compares to what’s going on in comparison to the “average” economy. When it appears that certain components of the CPI are increasing, you can pay closer attention to the items that more directly affect you. If you know that you will be paying college tuition soon, and you can see that education is taking off, you know that you will need to plan for that. If you have your home paid off, it doesn’t matter so much that rents are rising (unless you own rental property – in which case rising rent isn’t a bad thing). Knowing the most important components to your own personal economy can help you identify areas that might be more affected by larger trends, and help you see where you might try to save more money.

Adjusting Your Spending

Another way that looking at your own personal spending can help you improve your money situation is in changing your habits. When you see what you have been spending money on, it becomes apparent which categories are costing you the most – and what you can cut back on. A review of your spending habits, tracking them month to month, can be a real eye-opener. Once you have identified problem areas and money leaks, you can take steps to minimize your personal inflation. Making your home more energy efficient can help you reduce your exposure to inflation in the housing category. Growing some of your own food, and eating out less, can help you reduce your exposure in the food and beverages category. Look at your spending, and see where you might be able to change your spending habits. After all, you are less impacted by inflation when you spend less money.

Spending less isn’t the only way to protect against inflation, though. It is possible to do a little financial bargain hunting to lock in lower rates on loans, find value stocks at low prices, and even invest in commodities. You can also consider inflation adjusted securities, and try to find high yield cash products. All of these things can help you beat inflation – and are made more effective when you adjust your spending on different products and services.

Bottom Line

While “official” inflation figures can provide you with certain insights, it is possible to make better plans when you base them on your own personal spending numbers, since you will have a better idea of what, specifically, will impact you the most.



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