Remember when a can of soda cost a nickel? And candy bars were just a dime? Those days are long gone, as inflation over time has raised the price of just about everything. In the past, what your clients earned through wage gains or from their investments generally outpaced the rate of inflation. That difference, in the long term, has helped raise the overall standard of living of many people. Today’s inflation rates create a very different reality for your clients—one that is potentially quite frightening.
The most widely used measure of inflation is the Consumer Price Index (CPI). It is used to measure the changes in prices of all goods and services purchased for consumption by households. It is also an important measure of the overall health of the economy. Over the past 12 months, the CPI increased 2.9 percent, according to the Bureau of Labor Statistics. But does that paint the whole picture? Would you say the impact to your clients’ budget has been only 2.9 percent in the last year? Not likely.
The CPI number has, in the last few years, been suppressed by the decreasing cost of some non-essential but useful items, like televisions and computers. The things we have to buy—life’s essentials—are skyrocketing. In the last 12 months, the price of beef is up 11.5 percent. Milk is up 9.2 percent. Gas? Up almost 10 percent. And the prices for college and health care have routinely outpaced that of general inflation for a decade or more.
Calculating inflation’s toll
A recent study by the American Institute for Economic Research developed the Everyday Price Index (EPI) to better reflect the day-to-day experiences of Americans. What they essentially did makes sense. They tweaked the calculation to scale back the percentage on some of the bigger categories with products that consumers can delay or avoid purchasing and focused on categories that are needed and purchased on a daily or weekly basis. A nice, new 50-inch HDTV or an iPhone is a luxury to many, while breakfast and dinner or the gas for the drive to work is not. With these revisions, the EPI for 2011 came in at a staggering 8 percent—well above the 2.9 percent increase indicated by the CPI.
In reality, those with additional mouths to feed or who have above-average commutes are likely experiencing even higher rates. CPI and EPI are just different attempts to capture a majority of the prices people are paying for an “average” basket of goods. What really matters, at the end of the day, for all individuals, is that their own income is keeping up with their own expenses.
So where does that leave your clients? In a financially scary place. Today’s inflation rates present a very serious challenge for those living on a fixed budget or in retirement. At the 8 percent EPI rate, the average American will lose half his purchasing power in just nine years. Even at the CPI rate of 2.9 percent, purchasing power would be halved in 25 years. But people in or near retirement could still have several decades of need for inflation-protected income. Making the situation worse, interest rates are still near record lows, and most bank savings accounts, money market and CDs are yielding less than 1 percent.
“Going broke safely” is a situation where investors have unknowingly kept money in low-yielding accounts or under the mattress. While it allows investors to sleep at night, inflation, over time, will erode the purchasing power of that safe money.