How Do You Plan for Clients When You Can’t Trust the CPI?

I’ve never been a big fan of mixing financial advice and politics. Sure, advisors have their personal views, but their job is to help their clients reach their financial goals whatever the political climate. Still, there are a few areas where politics spills over into personal finance that simply cannot be ignored.

Sadly, the most obvious is the regulation of financial advisors and brokers. It seems as if adequate protection of financial consumers and retirees would be a bipartisan effort, but apparently the anti-regulation Republicans and the anti-small business Democrats can’t seem to get their brains around that. As I wrote in my January 16 blog, it seems to me that healthcare will increasingly become a political issue with major financial planning implications.

Another such political issue that’s unfortunately become an issue for advisors is inflation. I know, inflation hasn’t been much of a concern for anyone since the early ‘80s, and with the Consumer Price Index hovering under 2.5% annually for the past few years, it’s hard for most folks to imagine that inflation is any more of a concern today. That’s where politics rears its unwanted head.

In a January 22 column in Investment News, Euro Pacific Capital CEO Peter Schiff once again makes the case that all is not well with the CPI—and raises serious concerns for financial planners who use it in their retirement calculations. “Government statisticians are responsible for coming up with the methodology and the numbers [for the CPI],” writes Schiff, “and their bosses [the politicians]catch huge breaks if the inflation numbers come in low. Human behavior is always influenced by such incentives.”

(Schiff has been sounding the hyperinflation alarm in other venues as well, such as in this January 10 AdvisorOne article where he excoriates the Federal Reserve for its actions and calls the CPI number "meaningless."-Ed.)

According to Schiff, the problem started in the early ‘80s, when a new “chain weighted” CPI was created that factored out changes in consumer spending habits and increases in product quality. In theory, these changes probably made some economic sense, but in practice, according to Schiff and others, they served to under-report real increases in consumers’ cost of living. To quantify how much the CPI masks the real rate of inflation, he studied a basket of 10 common purchases (eggs, new cars, milk, gasoline, bread, rent of primary residence,, coffee, dental services, potatoes, and electricity) over various time periods including from 2002 to 2012. During those 10 years, the CPI rose only 27.5%, yet those modern staples increased some 52.1%—nearly twice what the government was reporting as our cost of living. 

The reasons for the discrepancy aren’t hard to understand. Simply by discounting product “improvements,” government economists are able to ignore substantial cost increases that are very real for today’s consumers. Consider cars, for instance: with digitally controlled engines and brakes, along with myriad bells and whistles such as electric windows, cruise control, electric seats, etc., there’s no question that a new car today is an upgrade over cars made 30 or even 20 years ago. The problem is that we don’t have the option of sticking with the older functionality: we have to buy all those bells and whistles, at the higher cost. While cars are an obvious example, the same forced upgrade applies to many of things we buy today, from toasters to telephones to shoes—even our eggs are now “Omega-3” enhanced.

Then, there’s the problem that we simply “need” a lot more stuff in today’s world. Not only are our high-tech cars more expensive, but how many families have just one car these days? Or even “just” two cars: it’s not unusual for families with kids to have four cars or more. And how many families have one TV? Or one phone? Or one computer? The technology explosion alone illustrates the real cost of living: how many families seem to feel the need for multiple iPads, iPods, Kindles, laptops, printers and Bluetooth devices?

These are all “costs of living” that are very real to advisory clients, yet are ignored by the CPI. What’s more, most of us won’t start getting rid of some this stuff until we’re headed to the nursing home, and maybe not even then: I can’t think of a demographic group with a greater need for social media tech, not to mention aids to mobility, such as a Segway. 

For financial advisors this poses a daunting task in projecting their clients’ future cost of living—upon which their financial plans so heavily depend. Perhaps the only certainty is that the CPI isn’t much help. I’d love to hear how you address these issues in your financial plans. 

In addition to commenting below on how you're accounting for future inflation in your clients' plans, you may want to read about the public scuffle between Peter Schiff and Larry Swedroe of Buckingham and BAM Advisor Services, and a CBS MarketWatch blogger, over gold.-Ed.

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