INFLATION AND THE CONSUMER PRICE INDEX
Why is price inflation so harmful to my retirement investments?
Inflation is harmful to your retirement investments for a variety of reasons. Since 1926, even with periodic market crashes and movements in the equity markets, the average return on one's investments have been approximately 11%. The inflation rate has increased by approximately 3.1% in the same time period. It is generally thought that we need to earn more on our investments than the inflation rate, since when we figure our real rate of return, we must subtract the rate of inflation from whatever return we are getting on our current investment portfolio. So if we are getting a 4% return on our investments, it is really a 0.9% return before taxes (after adjusting for inflation). This erosive effect is the main reason why we actively need to seek good investments that provide good returns on our principal.
What can I do to mitigate this inflationary risk?
The best way to mitigate the effects of inflation is to save during your high-earning years, and earn more on your investments than the average rate of inflation over a long period of time.
The Consumer Price Index is calculated using data based on prices that actual shoppers pay at the register.
What is the Consumer Price Index (CPI)?
The Consumer Price Index (or Indexes, as it is officially called) is created and published monthly by the U.S. Bureau of Labor Statistics. It represents data collected on the prices paid by urban consumers for a representative sample of many goods and services, in order to gauge changes in prices over time.
How is the CPI created?
The CPI is created both by real shoppers, who acquire specific goods, and by detailed interviews and price diaries kept by thousands of contracted families across the United States, detailing what they have purchased, and at what price, during a certain period of time. The basket of real products that are analyzed includes more than 200 categories of goods and services divided into eight groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. The Bureau of Labor Statistics also analyzes the prices of approximately 80,000 items in its market basket each month from thousands of retail stores, service establishments, rental units, and doctors' offices across the country.