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Government-Reported Inflation

This article was written by Flexo in Economy. 8 comments.

Over the twelve months ending with March 2012, the increase in the consumer price index (CPI-U) as reported by the Bureau of Labor Statistics, often referred to as the inflation rate, is 2.7 percent (2.3 percent if you exclude food and energy). While these numbers are below the historically-cited norm for inflation, 3 percent, the numbers are still troubling for some people.

Government-reported increases in the consumer price index do not tie to any individual’s experienced increase in the cost of living. No person can assume that if wealth grows by the rate of inflation that life is just as affordable as it was a year ago. For example, if my income was $100,000 in 2011 and $102,700 in 2012, although my salary would be keeping pace with inflation, it’s likely that I still would find that this year’s income would not afford me as much as last year’s income was able to afford me.

Helium balloon inflation With $100,000 in a high-yield savings account, the $750 I would have earned in before-tax interest not only loses to government-reported inflation, it would be pathetic compared to any rate of increase of expenses I experienced personally.

Part of the problem is that the CPI-U is calculated by measuring the change of price of a variety of consumer goods, but each type of good is weighted according to its importance. The level of importance is taken as an average importance across all citizens based in or near cities in the United States. Thus, the weighting may not be appropriate for any one individual. For example, as of the last CPI-U calculation, gasoline for vehicle fuel was weighted 5.7 percent. 5.7 percent of the year-over-year increase in consumer prices can be attributed to the increase in gas prices.

Any one family’s exposure to the cost of gasoline could easily be greater than 5.7 percent. A household with two incomes might involve a husband and wife who both commute an hour or more to, and an hour or more from, their places of work. For a family like this, the effect of an increase in gas prices could be much more devastating to their finances than the CPI-U would indicate. The increase in this category year-over-year is 9.0 percent. So if for any family, gasoline accounts for more than 5.7 percent of all expenses, the real cost of living would have increased more than the reported inflation rate.

We are often concerned with finding investments that provide a return higher than inflation. Financial planners consider inflation one of many benchmarks. If you want to maintain purchasing power with your funds, you’d look for a low-risk investment that meets or stays on par with the rate of inflation. The government even offers inflation-protected securities, whose yields are designed to artificially keep pace with the rate of inflation, thus providing investors a method of investing with a guarantee of not losing “purchasing power.”

The comparison between investment returns as experienced by one individual and a calculation of an average increase of prices is invalid. Financial experts continue to use the average inflation rate as a benchmark for individuals because it’s easy and can seem to apply to an entire population at once — even if it really applies to no one.

The criticism of the CPI-U as a personal rate of inflation doesn’t end with the idea that an average measurement doesn’t apply to any one individual. The method of calculating inflation has changed over time, and modern calculations are criticized for masking the truth. If the rate of inflation were to be calculated the same way it had been four decades ago, the rate would be significantly higher. The public is sensitive to bad economic news, and it’s safer for the government officials who are in power to continue to report subdued numbers. The Bureau of Labor Statistics should be free from political influence, but that’s an impossible ideal, especially over the course of a generation or two.

As a result of the realities behind criticism of the inflation rate, real inflation in the cost of living is destroying your net worth. Inflation keeps investors chasing returns that, while being better than earning nothing or losing money, are not high enough to continue a standard of living. Fifteen years ago, the most popular television sets might have cost an average of about $500. This was before LCD technology and high-definition became widespread. Today, the average cost of the most popular televisions might be $1,000. Today’s LED-backlit LCD HDTVs, while $1,000 today, would have cost more than $10,000 a few years ago when the technology was new. So in one sense, advancements in technology lower consumer costs, but offsetting that reduction is the consumer demand for better equipment, and that demand outpaces the decline in prices. Nobody’s buying the first generation iPad today.

Photo: Kai Hendry
Bureau of Labor Statistics

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How Do You Preserve Your Money?

This article was written by Flexo in Economy, Saving. 19 comments.

Preservation of capital is an important aspect of any financial plan, but in today’s economy, this is impossible without taking on some risk. At one time, you could confidently place any money you might need within one year in a high-yield savings account and be relatively confident that your money could buy at least as much a year in the future than it could buy the day you deposited your funds. Interest rates were relatively coordinated with the rate of inflation.

That’s not the case today. The Department of Labor released the latest inflation data. It should be no surprise to most consumers that the changes in the price of gas led to an increase in the energy index of 3.2 percent over the last twelve months (ending February). The inflation rate for all items is 2.9 percent. While the government-reported inflation rate doesn’t translate to the actual increase in expenses any one individual experiences year over year, it’s the best benchmark we currently have for a generalized view of the increase in prices.

And it’s the measure we use to determine how much purchasing power savers lose. If your savings account isn’t earning at least 2.9 percent after tax, you’re losing money in real terms by placing it in a bank. With banks offering less than 1 percent interest before taxes on their best high-yield savings accounts, purchasing power losses accelerate. Placing your cash under a mattress to earn zero interest is a worse idea, so are there any other options providing a safe way to maintain purchasing power?

Money Bags Not really. Using a savings account is great for funds you might need in an emergency, because you can access the money quickly without worrying about selling an asset. Savers have to understand that having an emergency fund is a compromise; in return for the safety of an FDIC-insured account, savers waive the right to preserve real value, at least in today’s economy.

Any other options for preserving capital introduce risk.

Investing in the stock market. Despite some recent frenzy about the stock market, with prices of the major indexes reaching near-term highs and day-over-day increases exceeding the best-performing day of the year thus far, there have also been daily price decreases reflecting the worst performance of the year. The stock market is incredibly volatile. For the long-term, it’s a good place to be, but there’s no guarantee that your capital will be preserved for when you need it.
Buying real estate. For years, families saw the house they live in as a way to store their wealth. The belief was unfortunately based on the myth that real estate values never decrease. Well, any asset can find itself in a bubble, whether they be tulips, stocks, or houses, and people who relied on real estate’s ever-increasing value to make a living have had a difficult time in recent years. It’s been terrible news for real estate flippers, but the effects hit single-house homeowners just as hard.

Although timing the market is always dangerous, with low prices and low interest rates, if you can qualify and if the time is right for your family, now could be the right time to buy a house, particularly if you’re looking to live there for a long time.
Buying Treasury Inflation-Protected Securities (TIPS). You can buy this investment product directly from the U.S. Treasury. Twice a year, you receive interest as well as an adjustment to your principal balance based on the inflation rate. This is basically a bond that will only lose value in the event of deflation. If you must sell TIPS after the value has dipped below your initial investment, you will still receive your full initial investment back.

There’s no risk in losing money, and this is the closest you might be able to get to true preservation of capital during inflation. Keep in mind, however, that the government’s reported inflation value doesn’t necessarily reflect any one household’s experienced rate of inflation. The government’s rate used for calculating TIPS adjustments, the CPI-U, uses the prices of a combination of goods that weights items in a way that might not be relevant to most consumers.
Buying gold. Investing in gold is traditionally a good way to hedge against inflation, but the price of gold fluctuates. Like all commodities, the value of gold at any particular time is subject to the whims of commodities traders. An investment in gold is not as stable as its reputation. The price fluctuation may be due to fluctuations in the value of the dollar or of any other fiat currency, but the cause is irrelevant because the U.S. dollar is the world’s standard for currency, and if that ever changes, it would be another currency or combination of currencies that becomes the standard, not a commodity like gold. The days of the gold standard are over.

Furthermore, most people who invest in gold use ETFs or mutual funds due to convenience. It would be inefficient and expensive to store and secure a significant amount of physical gold bars. Once you are dealing with electronic trades rather than a physical manifestation of metal, you’re subjecting yourself even more to the whim of the financial industry.

With low interest rates and increasing inflation, this may be a good time, from a financial perspective, to borrow money. You can do more with someone else’s money, repaying the loan with money valued less in the future. Borrowing money is of course not a good idea for people who could find themselves in trouble with debt, as interest costs could spiral out of control, but if you look at the numbers, borrowers are getting a much better deal, relatively speaking, than savers.

In today’s economy, if you are preserving your money, how are you doing so?

Photo: Lord Jim

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The Best Online Savings Accounts, May 2012

This article was written by Flexo in Banking. 223 comments.

The best online savings accounts offer high interest rates and great customer service. Savings accounts, particularly so-called “high-yield” savings accounts, are best for money you might need within a year. Any money that you don’t want to subject to the short-term risk and volatility in the stock market should be held safe in a savings account, earning as much interest as possible. Your emergency fund should primarily consist of money held in a high-yield savings account.

“High-yield” is unfortunately a bit of a misnomer these days; a decade ago, interest rates were 4% and 5% among select savings accounts and money market accounts. Today, the best rates are all below 2% while a fair amount are still hovering around 1%, many rates are now dipping below the 1% mark. This trend will continue until banks need more cash from depositors.

Interest rates. Interest rates are important because money shouldn’t lose too much purchasing power. In a perfect world, interest rates offered by banks should beat inflation while preserving the balance without risk. I am not aware of any bank offering a savings option with ongoing interest rates high enough to beat inflation, whether measured by the government-reported CPI-U or by any other meaningful measure of consumer prices. Nevertheless, if your savings is at a brick and mortar bank earning below 0.25% APY, choose one of the better options below.

Customer service. When evaluating customer service, there are two important factors to consider. The best banks offer all account maintenance and transfers through a professional, reliable, and easy-to-navigate website. Secondly, live customer service representatives should be knowledgeable, helpful, and available, although customers should have to deal with a representative infrequently if at all.

Based on my own experiences and reviews from other Consumerism Commentary readers, here are the most-recommended accounts for short-term savings. All of the listed interest rates are current as of May 2012, but they are subject to change by the banks. Although I have nine accounts listed below the table of rates, you don’t need to have accounts with that many different banks. Choose one that fits you the best.

First, here is a list of the latest interest rates. Following this table, I offer a few of my own observations and opinions about savings accounts from nine popular online banks. Read the full article →

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High-Yield Investing In a Low-Yield Environment

This article was written by Investor Junkie in Investing. 13 comments.

This is a guest article by Investor Junkie, focusing on alternative investments. This is a broad topic, so this article functions as a brief overview. There are many ideas within that deserve deeper explanation, something I’ll consider for future articles here.

Market turmoil is all around us. Last week, the 10-year US Treasury bond went below an unheard-of yield of 2%. Recently, the Federal Reserve formally announced that it will be keeping the Fed funds rate between 0% and 0.25% at least until June 2013. Savers are being punished, and traditional fixed income investments are yielding nothing. Investing for yield in this environment is very difficult. Where is one to turn to get some yield when a 5 year CD yields less than 3%?

In addition, inflation is expected to be around 3% this year, so any investment that yields less than this you are losing money in real terms. What are your options in this low yield environment? You do have no choice but to go up the yield curve. I won’t lie; some alternatives are risker than fixed income traditional fixed-income investments, though most have a low probability of default and generate much higher returns than government-secured investments. One could argue investments yielding less than the expected inflation rate is a risker investment. I would personally rather hold my money under my mattress than investing in a 10-year treasury bond.

Tokyo Stock Exchange Investing That being said, what are the options? Some are traditional investments, and others are alternative investments that you may have not considered previously.

Peer-to-peer lending
High-yield corporate bonds
Ginnie Mae bonds
I-Bonds
Municipal bonds
High dividend stocks
REITs
Master limited partnerships

Here is a brief summary of each of these.

Peer-to-peer lending

I’ve been investing with the peer-to-peer lending (P2P) service Lending Club for over two years. To see my process, read my Lending Club review for the details. So far I’m very happy with my 11.49% net annualized return. Peer-to-peer investing isn’t perfect though, and it is still a very new investment class. It has potential to be a viable alternative to high-yield corporate bonds, with possibly less risk. If we do see another recession, it’s possible P2P loans will default more frequently, and increased defaults will decrease investment returns.

High-yield corporate bonds

High-yield corporate bonds, otherwise known as junk bonds, offer higher yields than traditional government bonds and can be 3% to 4% higher than government fixed-income investments. Of course, the higher yields come with higher risk and have a higher chance of default. Unless you are investing six figures, you are best to diversify in this category via mutual funds or ETFs focused on these investments rather than buying individual junk bonds.

Ginnie Mae bonds

Ginnie Mae bonds are federally-backed bonds that offer higher rates than traditional government treasuries. With Ginnie Mae bonds it is often best to invest via mutual funds only because most investors will not have the capital requirements to buy directly. I discuss about Ginnie Mae investing in more detail on my blog.

I-Bonds

I’m a big fan of U.S. I-Bonds, and for the next 11 months these investments offer at least a 2.51% annualized return. That rate could be even higher depending upon the CPI calculation in October. Like government TIPS, I-Bonds follow the inflation rate. There are no state taxes to pay on interest. Federal taxes are only paid when you cash out unless the bonds are used to pay for higher education, in which case they are tax-free. Unfortunately savings bonds have an annual purchase limit, and the U.S. Treasury Department just announced an end to paper-based savings bonds. Next year, the maximum you can invest is $5,000 per Social Security number.

Municipal bonds

For higher-income individuals, muni bonds offer a decent after-tax return with a historically low chance of default. Unless you are investing six or more figures you are best to diversify via a mutual fund. Muni bonds typically offer 2% to 3% higher returns than federal government investments. The primary advantage to muni bonds is the lack of capital gain taxes, though in this low fixed-income environment, individuals in lower tax brackets might want to consider them as an investment.

Dividend stocks

Many dividend stocks have a higher return than government treasuries. You also have the added benefit of the stock possibly increasing in price over time. There are dividend ETFs that can diversify your investment. I personally like the dividend aristocrats, which have increased their dividends every year for at least the past 25 years. These might be considered boring stocks, but they typically offer decent returns for the long haul.

REITs

Real Estate Investment Trusts (otherwise known as REITs) are publicly-traded real estate companies. You can invest directly in a specific REIT or via a mutual fund or ETF. With the decline in commercial real estate prices, it might be a good time to get back into specific real estate sectors, and these investments have an almost inverse correlation to stocks. Traditionally REITs have offered a stable 6% to 7% return. REITs are typically best held in tax-deferred accounts because the investor’s profits are generally considered ordinary income rather than capital gains.

Master limited partnerships

This is one of the rarely-discussed investments that generates a consistently high yield, and low to payout in taxes. Master limited partnerships (MLPs) are similar to real estate trusts, but are usually best to invest in taxable accounts. Most MLPs are companies related to the transporting of commodities, such as natural gas and oil pipelines. Typically, their pricing is not related to price of the commodity itself, but based upon the transportation of that commodity. If you do your taxes yourself it might not be a good option to invest your taxable money. MLPs can be complex when filing your personal tax return. I discuss more about MLPs in detail on my blog.

To diversify your risk, one could invest in many of these above investments, and still yield a decent return that’s stable. This article is meant as a summary of possible investment options than can generate some yield. Please do more research before investing any of the above options. With any investment you should always determine your risk, and if unsure contact a professional. In case you didn’t know, all investments have risks. Past performance does not guarantee future returns.

How are you investing in this low yield environment?

tenaciousme

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Silent Inflation Is Destroying Your Net Worth

by Flexo

According to the government’s figures, inflation was a modest 2.7 percent over the twelve months ending in March. The Consumer Price Index (CPI) is the Bureau of Labor Statistics’ popular measure of economic changes affecting typical consumers in the United States. It’s a figure we often compare to after-tax savings interest rates, reminding us that our ... Continue reading this article…

16 comments Read the full article →

Annual Benefits Enrollment: My Cost Increasing 10%

by Flexo

The open enrollment period for my company’s 2010 benefits came to a close yesterday. My procrastination came to an end when I logged into our benefits management website, reviewed the options one last time, and decided to stick with the same plan I’ve had since I joined the company, an HMO plan offered by Aetna ... Continue reading this article…

19 comments Read the full article →

How to Prepare for Inflation and Higher Prices

by Flexo

Yesterday, the Federal Reserve purchased $7.5 billion of debt in the form of Treasuries from the government, and plans to continue buying debt for a long time to finance the government’s spending. As the government continues selling this debt, the money supply increases. In total, the Treasury may add $3 to $4 trillion dollars to ... Continue reading this article…

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Search: cpi

Government-Reported Inflation

How Do You Preserve Your Money?

The Best Online Savings Accounts, May 2012

High-Yield Investing In a Low-Yield Environment

Peer-to-peer lending

High-yield corporate bonds

Ginnie Mae bonds

I-Bonds

Municipal bonds

Dividend stocks

REITs

Master limited partnerships

Silent Inflation Is Destroying Your Net Worth

Annual Benefits Enrollment: My Cost Increasing 10%

How to Prepare for Inflation and Higher Prices

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