The Consumer Price Index (CPI, or CPI-U as the Consumer Price Index for All Urban Consumers is the primary CPI measure used) is something of an enigma to most people. There’s sizable confusion about what it is and what it isn’t, which may be due to the sheer enormity of it (the CPI-U has 393 line items – the Bureau of Labor Statistics, or BLS, is nothing if not thorough). The goal of the CPI-U is not to help consumers understand their own annual inflation rate. No broad-based statistic, government or otherwise, could do that. Instead, the CPI-U is meant to give a much broader, economy-wide measure of inflation.
May 2018’s CPI-U indicated a year over year inflation rate of 2.8%. This, for the most part, doesn’t mean much to you and me. Instead, our personal inflation rates are going to depend on the choices we’ve already made. Do you live somewhere where you have to drive everywhere? Gas prices are going to matter a lot. Do you eat out a lot as opposed to cooking at home? The “Food Away from Home” category will matter a lot. Do you rent instead of own your home? The “Rent of Primary Residence” line item is most important to you.
Few people find it enjoyable to dig into the CPI and calculate their own personal CPI. Fear not – Our Family Fortune has done our family’s CPI as an example. For the most part, your personal CPI will be dominated by a few categories. I was surprised at both how much our numbers resembled the CPI-U and how little they resemble it. Before jumping into category by category, below is a summary of how our family’s inflation rate looked from May 2017 to May 2018 compared to the CPI-U.
Shelter and House Operations
Shelter is likely going to be where you differ most from the government reported CPI. For those living on the coasts or in other high-priced locales, this number will be a much higher percentage than CPI-U. Renting versus owning your own home will also create a big difference. A combination of no mortgage and two homes made this number both larger than I would have thought and smaller than the national average. I also threw “Household Operations” (a 0.87% category) that includes lawn services, moving services, and gardeners, in with the larger “Shelter” category. Shelter is primarily broken down between rent and a concept called owner equivalent rent, the amount that you would have spent in rent to rent a house similar to what you own.
The level of inflation (3.5% over the last year) is driven by increases in rental prices. This causes the biggest difference with homeowners. Homeowners locked into a 30-year mortgage will only experience increases from property tax and homeowner’s insurance, while their actual “rent equivalent” payment will stay the same. In other words, most homeowners will have a far lower level of inflation than the stated 3.5%. Keep in mind that this is only due to rental prices increasing, so if rents stagnate or even decline, a homeowner may have higher inflation than a renter.
Although we don’t have a mortgage on either home, we do still have two homes with the corresponding bills that go along with them. The combination of property tax, insurance, and repairs accounted for nearly 25% of our budget – a number that surprised me quite a bit. If we had mortgages, our housing expenses would be substantially higher than the 33.6% weight in the CPI-U. Our experienced inflation was also higher than I had thought, driven by a 5.6% increase in property taxes!
The size and impact from inflation in this category demonstrates that minimizing housing costs is one of the best ways to save money.
Commodities less food and energy commodities
This verbose category name is just a way of describing all of the consumer goods we need and want living in a developed country, excluding food and energy since they are measured separately. It includes window treatments, furniture, appliances, indoor plants & flowers (a separate category that makes up .09% of the CPI-U and increased by 2% last year!), tools, and clothing. This category will be highly dependent on your own personal choices. For example, we tend to live pretty simple lives, but we moved in the last year to a new home and had higher than normal expenses related to new furniture and other household needs. To account for that, I took an average of the last two years. Otherwise, this category would have been much higher for us last year but not an accurate ongoing representation of our buying habits. This phenomenon is what makes comparing your personal inflation rate to government stats so difficult.
According to the CPI-U, this category actually saw modest deflation of -0.1%. I am not enough of a sadist to go over every expense for the last several years, but we have not noticed a meaningful increase in any of these expenditures. Anecdotally, I have seen that appliance costs are up 20% year after year due to new tariffs, but since few people buy appliances each year, it’s tough to say how impactful that is. I took the easy route and assumed a 0% increase.
The BLS breaks food down into two categories: groceries you buy for cooking at home and eating out. Much like the consumer goods category above, this category will be heavily dependent on your lifestyle. It is also fairly easy to adjust if pricing gets too high – if restaurants get too expensive, you can always eat at home more.
Again, I’m not enough of a sadist to compare the prices of apples or milk year over year. I can say anecdotally that it seems like prices in the grocery store are going up, but I can’t really prove that. Our grocery bill has been surprisingly consistent, although it’s been going up as we added kiddo number three this year. That’s more based on our personal situation than prices generally. We buy mostly organic but less meat than most, so our total spending comes in below average on total grocery purchases.
We also spend much less at restaurants than average, mostly due to the fact that it’s a real pain to take three kids to a restaurant. Instead, when we do go out, fast casual places like Qdoba or Panera Bread are our choices as opposed to a full service restaurant.
Much like food, energy is broken into two categories: automobile gas and utility services like electricity. Interestingly, home heating oil and piped-in natural gas, while fulfilling the same basic function of heating your house, are put in separate energy categories. Much like most of the country, our gas prices have gone from roughly $2.25 per gallon to something closer to ~$2.80 a gallon, a 25% increase in our area. This broadly matches the country as a whole, although it appears to be a bit higher.
Utilities services are somewhat buffered from fuel price changes because of flat-fee service charges and taxes which account for anywhere from 10%-50% of the bill (depending on the time of the year). Also, because these are regulated utilities, the utility must get permission for passing through rate increases. Nonetheless, our fuel charges have increased modestly so we have seen a slight increase in our monthly bill. Again, they’re a bit higher increases where we live, but comparable to the broader economy.
Transportation, much like shelter and consumer goods, is going to be one of the categories where you’ll see the biggest divergence from the CPI-U measure. The bulk of this category relates to new and used car and truck sales. Given that most people don’t buy cars every year, this category will be nearly irrelevant most of the time. Insurance and fees are also included in this category, which is where most families will notice price changes but on a much different scale than CPI-U.
In this category, our only expenses are related to insurance, registration fees, and the occasional car repair. While the amount we spend on cars still surprised me (over 5% of our spending without car loans!), the annual change did not. As opposed to an economy-wide increase of 3.8%, we saw a decrease in costs. Our car insurance actually went down this year, as well as our car registration (car registration prices are based on value of the automobile, which also declines each year).
Recreation services should be thought of as two categories: subscription TV services and all the other fun stuff. We were among the first cord-cutters, so our subscription services are non-existent on the TV front. However, I included the cost of our vacations here, which pumped up the category weight a bit. This category is one of the easiest to adjust based on prices at large. If money is tight, we can choose to cut back on fun stuff and vacations, or just do cheaper versions of each of those. Most people should find this category highly variable based on how well their financials look.
Education and Communication Technology
There are certain categories of the CPI that make you scratch your head. The combination of education and communication technology (cell phones and internet) is one. I really don’t know why these two categories are combined into one. Nonetheless, this category is a particularly relevant one for parents.
While our cell phone plans and internet service both have locked pricing, we include our contributions to the kids’ 529 plans in this category. Hence, even though this could be thought of as an “investment” in our children’s college, we treat it as an expense. This also allows for a great deal of flexibility. We could stop college savings at any time, since you do not have to pay for college for your kids. This category would drop by 90% if we did that.
More broadly, from the CPI-U statistics, I was surprised that college tuition went up “only” 1.7% last year, leading to a smaller than expected 0.7% increase for the overall category. Maybe the ongoing 5-10% increases in tuition each year are beginning to temper a bit. As parents who expect to contribute to college costs, we can at least hope this is true!
Medical Care Services
This category ranks as probably the most complicated to think about. The CPI-U tries to measure broad costs of medical services, but most of us don’t actually experience medical costs that way. Instead, we generally all pay for medical insurance and then pay any deductibles or co-pays that go along with each service.
Our situation is particularly unique because we have a high-deductible health care plan with an attached health savings account. I really like our plan for three reasons. One, because it’s a high deductible plan, our premiums are pretty low, especially for a family of five. Two, my work fully funds my HSA up to the legal max each year without me contributing a penny (a REALLY nice perk, I know). Three, I know that once we hit that annual deductible (about $7,000 per year), insurance covers 100% of any additional expense. We often pay more “out-of-pocket” for normal medical care, but have a well-defined limit for anything major. This provides quite a bit of peace of mind, because nothing is scarier than owing a five or six figure medical debt from a single event. We know that we’re capped and can’t incur huge medical fees so long as we have our insurance.
In the last year, our premiums went down but the annual deductible limit went up slightly. It’s a wash overall, but compared to the broader economy, our medical expenses actually went down slightly.
Water and sewer and trash collection services
Well, this category is as straightforward as it gets. To some extent, I wish the BLS just had a broader category for “Utilities” that would include home heating, electric, garbage, water, internet, phone, and TV. That’s how we, and I suspect most people, think about our expenses. Nonetheless, water, sewer, and trash collection are a small monthly bill that hasn’t really changed much year over year. My guess is that it’s pretty inconsequential for most.
One particular category that I think is missing from the CPI-U is charitable giving. The average American gives anywhere from 2-7% of their expenses each year to charities. Ours comes in slightly above that, at over 8% of our expenses. We consider it a separate expense category, although I’m sure it would be difficult to determine a rate of inflation for this category. The BLS has tackled more difficult categories, so why not this one? Like many parts of the CPI-U, this category is optional for everyone but is also one that most Americans spend money on. I suppose the argument could be made that the inflation associated with charitable giving is already in the CPI-U since these charities spend the money in the real economy. I find that to be a bit of a cop out though.
What’s Your CPI?
Calculating our family’s CPI was an interesting, albeit a largely futile exercise. While parts of it were illuminating (a 5.6% increase in property taxes!), others were just kind of ho-hum. The biggest takeaway from this will be that each family’s annual inflation rate will be different and will largely be driven by personal choices. Renting versus buying will result in different numbers as will the amount you drive or how often you eat out. Many of these categories will be highly variable based on how well you are doing financially. Those with more disposable income will ultimately spend more on consumer goods and eating out while those with less will focus more on the basics.
The CPI-U does not attempt to mimic your personal inflation rate. Seeing the headline number should not cause anyone to panic or to become complacent. A high economic inflation rate does not have to equal a high personal inflation rate, but a low economic inflation rate does not mean a low personal inflation rate either. You must remain diligent in order to keep expenses modest relative to income and cut back when certain parts of your budget increase sharply.
Keep building my friends.