The Consumer Price Index: The Importance of Knowing Why You Can't Afford Things Like You Once Could

If you watch the “news” or keep up with market trends, then you are familiar with titles like, “The highest inflation in 40 years”, “Will inflation ever end?”, or “How inflation will impact your life and the market for years to come”. Neither of these examples are necessarily misleading or inaccurate, but it is important to understand what the Consumer Price Index is and how it correlates with inflation, and ultimately your life.

The cost of living is something that’s always on our minds. Whether we’re thinking about putting gas in our cars or food on the table, we’re constantly mindful of how much things cost and whether we can afford them. That’s why the Consumer Price Index (CPI) is such an important measure. It tells us how prices are changing over time for a basket of goods and services that are representative of what typical consumers (all of us) purchase. We will dive-in to explore CPI in a little more depth and talk about why it matters to you. Okay, maybe not dive, but jump in. Actually, just the toes. Kidding, maybe.

What Is CPI?

The Consumer Price Index (CPI) is a measure of the average change in prices over time paid by consumers (you) for a market basket of consumer goods and services. The “market basket” used to calculate the CPI includes more than 200 items, ranging from housing, healthcare, and transportation costs to recreation, education, and even restaurant expenses, to name a few. Every month, the Bureau of Labor Statistics (BLS) releases the CPI report which includes data on inflation. This report can have a big impact on your savings and investments, so it’s important to understand how it works. The BLS uses data from surveys of roughly 26,000 retail outlets to calculate changes in prices for different categories of goods and services.

What is Inflation?

In order to understand the Consumer Price Index, it is important to first understand inflation. Inflation is the rate at which prices for goods and services rise. You know, the thing that every news channel is discussing lately. As mentioned above, the CPI measures changes in prices of things like food, shelter, clothing, transportation, medical care, and entertainment. When the CPI goes up (increased inflation), it means that consumers are having to pay more for these items than they were in the past. Which ultimately means the things you need and enjoy doing require more of your time and effort to be able to afford them.

Why Does CPI Matter?

CPI is one of the most closely watched economic indicators because it provides a snapshot of consumer inflation. That’s important because inflation can have a major impact on your standard of living. For example, if prices are rising faster than your income, then you’ll have less money to spend on other things. Inflation can also impact your investment portfolio, as we all have seen over the past year. If inflation is low, then the purchasing power of your money will be relatively unchanged over time. But if inflation is high, then your money will buy less in the future than it does today. You know the mantra “Work smarter, not harder”? Yeah, well, inflation makes it very difficult to do that.

The CPI affects different groups of people in different ways as well. The CPI can have a big impact on retirees and people on fixed incomes. That’s because their spending power decreases when prices go up but their incomes don’t. Inflation can also affect people who are trying to save money. When prices go up, the same amount of money can buy less. This can make it harder to reach financial goals like buying a house or retiring early because the value of your money, when not in assets, depreciates (goes down in value) at a faster pace.

How Does Inflation Impact My Savings Account?

Inflation can have a serious impact on your savings account. For example, let’s say you have $10,000 in your savings account and there is 3% inflation — which is low seeing that our current annual inflation rate is over 8%. In one year, your $10,000 will only be worth $9,700 in purchasing power. This means that if you want to maintain your standard of living, you will need to earn more money or save more money each year just to keep up with inflation.

It is also important to remember that the CPI only measures changes in prices for goods and services. It does not take into account changes in wages or other factors that can impact your standard of living. This is why it is always important to carefully track your expenses and make sure that your budget reflect changes in the cost of living, otherwise you may end up not saving, investing, or allocating funds to keep up with these changes.

How Does Inflation Impact My Investment Account?

With 58 percent of Americans having some form of stock market investment, you may be wondering how inflation impacts your personal portfolio or 401(k). The answer depends on what type of investments you have, and in this modern scenario, how bad inflation actually is and how long it persists. For example, if you have investments in stocks or mutual funds, inflation can actually be beneficial because it usually leads to an increase in corporate profits. Those benefits are usually seen months or even years down the road depending on how long inflation hurts purchasing power and future valuations. On the other hand, if you have bonds, inflation can be detrimental because it reduces the value of fixed payments from bonds. In the current market, both the bond and stock market have been struggling with stabilizing.

What Does This All Even Mean?

If you have any takeaway from this, it is that the Consumer Price Index (CPI) is an essential measure of inflation that can help predict changes in interest rates, and really your entire life. The more pressure on consumers from higher inflation typically leads to increased interest rates to tame demand. Decreased demand then leads to an increase in supply, which ultimately means lower prices for consumers. Sounds easy enough, but there is temporary pain to achieve this.

It is important to pay attention to the CPI report when it comes out because the more you know and how the results impact your life, the easier it will be to make the necessary adjustments to ensure you come out of any scenario on-top. Oh, and the next report comes out on my birthday, November 10th, so I am hoping the report comes in lower so that it is a gift to all of us.

Silver Lining

Regardless of what the results are when the data is released on Thursday (11/10/2022), just remember that the market, just like life, is cyclical. There are always rough patches and chapters in life, but the sun always rises the next day. It is with that perspective that we look forward and find ways to plant seeds even in the midst of what may seem like an endless inflation storm.

*This is not financial advice. For educational purposes only.