Two Ways to Combat Household Inflation

Inflation is not a one-size-fits-all all phenomenon

• Inflation is the increase in prices over time
• Increasing prices means decreasing purchasing power
• How we choose to spend our money dictates how we experience inflation

Inflation has been top of mind for every participant in our economy for three years straight: households, businesses, and policymakers. Inflation will loom large again this year as the Fed tries to guide us to a soft landing, which we discussed in our recent market update. Today, we zoom in on the macroeconomic landscape to how inflation affects households and what they can do to control it at home.

What is inflation?  

Inflation is defined as an increase in the prices of goods and services over time. Since the same goods and services cost more, we often say that inflation equals a decrease in purchasing power.   

How is inflation measured?

We have two popular inflation measures. Most people think of the Consumer Price Index (CPI) from the Dept of Labor. It tracks the cost of goods consumers report buying, and was up 3.2% year-over-year when February numbers were reported last week. The Fed relies on the Personal Consumption Expenditures (PCE) index, which surveys producers on what they have sold. PCE was up 2.4% in January, the most recent report. The Fed has a 2.0% target for PCE.

We can drill down on the two inflation measures to find out what is driving the change in the topline inflation numbers. The chart above shows relative importance- how much each spending category affects the index.  We can imagine these weights being percentages in a family’s budget and make a couple conclusions:

1. Housing is a major component of people’s spending
2. Consumers majorly underestimate what they spend on healthcare

Inflation is Not Uniform

Yes, at the macro level, inflation equals increase in prices, which equals a decrease in purchasing power.  But we do not all spend our money in the same proportions.  When the CPI peaked at nearly 9% two summers ago, about 2.6% was associated with housing.  Most of our clients own their primary home, either with fixed-rate mortgages or outright.  Their experience of inflation was limited to the cost of utilities, goods at Home Depot, and services like lawn care.  Their personal inflation rate may have peaked at less than 7% rather than closer to 9%.       

Two Ways to Limit Household Inflation

If inflation is not uniform, then the way to guard against it is to fix and limit the largest and most volatile pieces of the American household budget.  Home ownership is the #1 inflation hedge because that’s where we spend the most dollars and where much of the market cycle inflation volatility is centered.

The second best place to limit inflation, especially over a lifetime, is in healthcare.  Unfortunately, it takes a lot more work than buying a house. Utilizing preventive care and regular health monitoring can avoid chronic conditions that increase lifetime costs. Saving inside an HSA can help smooth out the lifetime cost of healthcare by prepaying some retirement expenses.  Ultimately, the most impactful action we can all take is to improve our diet and exercise habits, which are key preventers of volatile healthcare costs while we’re working and in retirement.

SOURCES:

CPI Relative Importance: (Author’s consolidation of CPI-U US City Average)  https://www.bls.gov/cpi/tables/relative-importance/home.htm#Weights

CPE Relative Importance: (Author’s consolidation of Table 2.4.5U) https://www.bea.gov/sites/default/files/2024-02/pi0124.pdf

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