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Why You Should Never Trust Inflation Numbers

Why You Should Never Trust Inflation Numbers
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Cody

Creator at Fly to FI
Cody is a 22-year-old entrepreneur, life optimizer, and creator of Fly to FI. He is a personal finance junkie who constantly tracks his net worth with Personal Capital.

In his spare time, he enjoys exploring the globe for FREE using a technique called travel hacking!
Cody
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I’m sure you’ve heard the term inflation before. But what does it mean? How is it calculated? I’m here to break down all the confusion about what inflation actually is. It might surprise you that your inflation number can be vastly different than somebody else’s!

Merriam Webster defines inflation as “a general increase in prices and fall in the purchasing value of money.” These prices are calculated by the Bureau of Labor Statistics using a metric called the CPI (Consumer Price Index). However, in the financial independence community, prices don’t affect us the same as the average consumer.

Problems with the CPI

The CPI or Consumer Price Index was created to represent the price changes in average consumer expenditure. There’s one small problem with this though. In the financial independence community, WE ARE NOT AVERAGE!

Here is the chart from the BLS depicting how the CPI factors changed from March to April 2018:

CPI Categories Percent Change April 2018

The chart shown above is certainly informative, but the chart we really care about is the “Relative Importance” chart, which depicts how each category is weighted. If “Fuel Oil” prices increased by 23%, but only represented 0.01% of the CPI, then that price increase would have a negligible impact.

CPI Categories Relative Importance April 2018

This chart is ten times more useful in determining how inflation might affect your lifestyle costs. I will walk through each specific category and explain why many of them do not accurately represent the FI community.

Food – 13.3% of CPI

Within the food category, Food at home accounts for 7.3% and Food away from home makes up 6.0%.

For many in the FI community, the Food away from home category is a non-factor. If eating out is not typical for you, this CPI factor does not affect you much!

The Food at home category is harder to avoid since everybody needs to eat, but it may not affect you as much as you’d think. I have a personal example that illustrates this perfectly.

My girlfriend and I used to buy black beans for $0.79 every week for a Mexican-style dinner. One week, prices increased to $1.29 and never returned back down to the glorious $0.79. So what did we do? Now, we buy the $0.79 kidney beans instead! I can imagine that many of you cost-conscious readers would do the same.

Energy – 7.6% of CPI

The energy category consists of two segments: Energy Commodities and Energy Services. Energy Commodities include Fuel Oil and Motor Fuel. Energy Services include Electricity and Gas.

This category seems extremely difficult to avoid, but don’t forget that the CPI uses the average costs for each segment.

If your Energy Commodities costs increase, you may look for a cheaper oil provider, or drive an extra mile to save $0.20 per gallon on gas. If your Energy Services costs increase, it might be time to look at different providers OR consider renewable energy.

Commodities (Excluding Food and Energy Commodities) – 19.9% of CPI

This is perhaps the least impactful CPI category for the FI community. The Commodities category includes Apparel, New vehicles, Used cars and trucks, Medical care commodities, Alcoholic beverages, and Tobacco and smoking products.

For me personally, nearly none of these segments affect me. I buy the cheapest clothes possible, never buy new vehicles, rarely purchase medical care commodities, drink cheap alcohol, and don’t smoke. The one segment that may affect me is the price of used cars, but I plan on driving my current car until it dies.

Even if you do purchase or use the commodities in each of these categories, searching for the cheapest option can help you to avoid the bulk of inflation. Remember, the CPI tracks the average prices for these segments, not the lowest prices.

Services (Excluding Energy Services) – 59.1% of CPI

The three leaders within this segment are Shelter (32.7%), Medical care services (6.9%), and Transportation services (6.0%).

The cost of shelter accounts for nearly 1/3 of the CPI. For homeowners, this segment has a negligible impact (Edit: Property taxes do rise as the value of your home rises!). Fortunately, the monthly payments on your fixed-rate mortgage will not increase with the rate of inflation. If you own your home free and clear, even better!

Additionally, a savvy renter can largely avoid this inflation factor by searching for the cheapest housing options. Or, he can take it one step further and completely eliminate his housing costs through house hacking.

Medical care services are certainly one of the most difficult inflationary segments to avoid. However, there are some low-cost options for healthcare providers. In preparation for quitting my job next year, I have looked heavily into HealthShares as an alternative to traditional Healthcare options.

Inflation associated with Transportation Services is also tough to avoid. If the train is your ride to work every day, there’s little you can do to dodge an increased ticket price. If you’re up to the challenge, one option may be to start riding a bike!

So Does Inflation Matter?

In certain scenarios, inflation can actually be beneficial. I’m sure all of you landlords reading this love rent inflation! Additionally, wage inflation isn’t so bad either! If you’re able to master the inflation game, you can grow your income and minimize your inflationary expenses.

Inflation is important for calculating your retirement plan and projecting future expenses. However,  inflation affects every individual differently. Understand which inflation factors affect your life and determine how substantial their impact is.

It would be foolish to assume that someone could live comfortably today on the average salary in 1913. There are some inflationary factors that just can’t be avoided. But, with careful planning and frugal habits, you can minimize inflation’s effects on your lifestyle.

In the Fly to FI community, we are not average! Live intentionally and beat the inflation game.


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8 thoughts on “Why You Should Never Trust Inflation Numbers

    1. Thank you Mrs. PocketChange! I really don’t like when people just assume an arbitrary “3%” inflation for their retirement projections. In the financial independence community, we can beat inflation!

    1. Glad you enjoyed. It’s a total mindset shift, but I definitely think financial cautiousness can curb spending inflation. Thanks for reading Allen!

  1. One thing missing in housing costs are property taxes. This is not at al, taken into account in inflation numbers but is a real cost increase to any home owner. My house value has only gone up 1% in 5 years but my property taxes have increased 20% for an additional $3k each year. Beware of expenses not included in inflation numbers.

    1. Hi Jill,

      Thanks for reading! You certainly make a great point in regards to your scenario. This post was just looking at expenses through a bird’s eye lens in the interest of word count.

      I’m curious, what region do you live in? That level of increase in property taxes seems like an anomaly. Property tax is usually calculated as (Assessed asset value x Millage Rate), so it’s crazy that your taxes have increased by 20% while the home value has only increased by 1%… would love to hear more!

  2. Different products in different locations inflate (or deflate) at different rates – as the different inflation rates in your post show. This makes relying on a general inflation index unreliable, especially for us money-conscious people, because, as you said, we’re not average!

    1. Thanks for reading, Joe! Definitely have to agree with you. If you find arbitrage opportunities due to different geographic locations, then go for it! As long as you are intentional with your money and understanding that there are different options, you’ve beaten the inflation game. We are most certainly not average!

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