I’ve been reading a lot about inflation lately and the potential impact it can have on households. I’ve also received questions from clients about inflation projections going forward. Some of the current thoughts around this issue relate to a “personal inflation rate.” In other words: How does the current inflationary environment affect individuals?
This makes sense to me, as everyone spends their money differently. Budgets tend to be more impacted in the areas where you absolutely need to spend money, or the non-discretionary part of your budget. Of course, if the high levels of inflation continue, the potential for inflation to impact the discretionary part of your budget may also become an issue.
Breaking it down, non-discretionary expenses are things like mortgage or rent payments, insurance premiums, car payments, food, energy usage, water, school tuition, etc. Discretionary expenses potentially include personal travel, dining out, club dues, alcohol consumption, new cars, new homes, etc. – all things that consumers can adjust their spending habits on to account for the sensitivity of their household budget to inflation.
My ‘Personal Inflation Calculator’
In the interest of trying to work through this on my own, and to provide guidance to our clients who are concerned about the impact of inflation on their own planning, I created a “Personal Inflation Calculator” using the latest numbers from the Bureau of Labor Statistics. If you’ve never looked at the monthly reports from the BLS, they are quite extensive, and cover quite a few common budget items. They are also broken down into “seasonally adjusted” and “unadjusted” inflation rates for each item.
Seasonally adjusted numbers take into account normal inflationary increases due to seasonal adjustments and removes their impact from the calculation. For example, gas prices tend to increase around holidays and the summer vacation travel period. Other items’ prices may increase or decrease around the winter holidays. Unadjusted rates just look at the raw numbers and increases in prices from period to period.
Based on the current economic environment, and the rapid pace of inflation, I’m focusing only on the unadjusted inflation numbers from May ’21 to May ’22. Seasonally adjusted estimates will most likely differ in some respects, but the unadjusted rate should give us a worst-case scenario. As stated in the BLS May report, “The unadjusted data are of primary interest to consumers concerned about the prices they actually pay.”
The worksheet I created takes some of the most common categories of household expenditures and allows us to enter annual amounts for those categories. The inflation factor for each item is than applied, resulting in an estimated price for that item or service in the current period. We then total all of those budget items up and develop a personal inflation rate from the difference. I think this can be most enlightening if we enter budget items based on the prior year’s estimates, to illustrate how prices are changing in real time. I’ve also added a few line items for occasional purchases, like a new or vacation home, or a new car, so that we can look at the effect of inflation on those particular items.
The end result is that we can fine-tune an inflation rate for a particular individual or family, as opposed to the blanket rate that is typically quoted for the entire economy. For example, if someone has a very low-cost lifestyle but relies on fuel oil to heat their home, they will have a higher personal inflation rate than someone heating their home with electricity.
A Test Case
I approached my test analysis assuming that we would start with budget estimates for the 2021 calendar year and attempt to predict how a typical household budget would be affected in 2022. Some interesting observations came to light.
In case No. 1, I considered a family of four with two young children and an annual household budget of $108,400. This includes such things as (in 2021 annual amounts):
- Mortgage: $18,000
- Auto loans: $7,200
- Credit card payments: $2,000
- Property tax: $4,000
- Groceries: $10,000
- Gasoline: $3,600
- Natural gas: $1,200
- Electricity: $1,800
- Airfares: $3,000
- Lodging away from home: $1,500
- Dining out: $6,000
- Pet food: $1,200
- Veterinary costs: $600
- Wireless telephone services: $1,400
- Cable TV: $1,800
By my calculation, based on their budgeted expenditures, this family’s inflation rate comes out to 8.53%, which brings their 2022 budget up to $117,650. This family may have to take steps to limit this projected increase, and chances are, they are already feeling it.
Your Own Inflation Rate Will Differ
When figuring your own personal inflation rate, you should realize that some budget items are not going to increase for the foreseeable future, such as fixed debt payments (home mortgage, auto loan, etc.). However, credit card interest rates are certainly going to increase – along with the general rise in interest rates related to inflation, as are many other things, such as food, travel, gasoline and utilities.
And the costs of some of the budget items are actually expected to decrease, such as “Food at Elementary and Secondary Schools” and “Computers, Software, and Smartphones.”
The biggest increases (unadjusted) are in the following areas:
- Home prices: +20%
- Rent: +5.2%
- New car prices: +12.6%
- Used car prices: +16.10%
- Gasoline: +48.70%
- Fuel oil: +106.7%
- Electricity: +12%
- Natural gas: +30.2%
- Airfares: +37.8%
- Lodging away from home: +19.3%
- Dining out: +9%
- Food / groceries: +11.9%
- And, the perennial favorite, health insurance: +13.8%
As you can see, there are some discretionary items in this list, and some non-discretionary items. So, depending on your particular spending plans, your personal inflation rate will vary. For instance, if our hypothetical family of four decided last year that they would buy a new home this year, costing around $300,000, their personal inflation rate becomes closer to 15.03% on a seasonally adjusted basis and 16.96% on an unadjusted basis (of course, if they had been renting, and through their home purchase were able to reduce their annual outlay in the process, they’ve just reduced their personal inflation rate).
If they had planned to buy a $35,000 new car this year, their personal inflation rate rises to 9.53% on an unadjusted basis. If our family of four had plans for more extensive family vacations this year, and we increase their airfares to $7,000 and their lodging away from home to $5,000, their inflation rate goes to 9.87% This is without buying a house or a new car.
Some Quick Takeaways:
- Depending on the sensitivity of your budget to items that are showing higher inflation rates, you may want to consider delaying purchase of those items, assuming they are discretionary in nature, such as homes, cars and increased travel.
- Take steps to pay off adjustable-rate debt, such as credit cards.
- Consider making your home more energy efficient (although this may expose you to higher inflationary costs from remodelers), and if you start to see higher utility bills, think about shopping energy providers.
- Renting vs. buying a home is a tricky challenge right now, because even as rents increase, mortgage rates and home prices are rising as well. However, considering that the projected rise in rents is +5.2% and the year-over-year increase in the price of homes nationwide was +20% in February, possibly delay buying a home until home prices fall to a more reasonable level.
- If you have an adjustable-rate mortgage, meet with your adviser to determine whether this should be refinanced to a fixed rate.
- Possibly delay purchasing a vacation or second home until this situation resolves itself.
- The cost of groceries is rising at a slightly higher rate than the costs of dining out. This may give you pause when thinking about cooking all of your meals at home. However, maybe consider cutting back on the more expensive menu items, as well as high-cost beverages.
In conclusion, the constant drumbeat of scary inflation numbers has everyone worried. However, if you take a few minutes to revisit how you spend your money and calculate your own personal inflation rate, you may come up with some solutions to put your mind at ease.
You can get a copy of my personal inflation rate calculator here: https://info.artifexfinancial.com/personal-inflation-rate.
Founding Partner, Artifex Financial Group
Doug Kinsey is a partner in Artifex Financial Group, a fee-only financial planning and investment management firm in Dayton, Ohio. Doug has over 25 years experience in financial services, and has been a CFP® certificant since 1999. Additionally, he holds the Accredited Investment Fiduciary (AIF®) certification as well as Certified Investment Management Analyst. He received his undergraduate degree from The Ohio State University and his Master’s in Management from Harvard University.