Don't let inflation get you down

During much of the 1990s, inflation has been out of sight and often out of mind. Yet inflation may be making an appearance once again, striking fear into the hearts of investors and that inflation watchdog, the Federal Reserve.

We typically hear about inflation through the monthly publication of the consumer price index (CPI). This is a measure taken by the U.S. Bureau of Labor Statistics of the average change in prices paid by consumers for a fixed market basket of goods and services. The basket includes food, housing, clothes, transportation and medical care. The measure is taken monthly and then annualized. The CPI also is used to adjust federal annuities under the Federal Employees Retirement System and the Civil Service Retirement System.

Through May, the CPI had risen 3.1 percent during the previous 12 months. For the first five months of 2000, the CPI climbed at a rate that projected to the end of the year would be 3.6 percent. Although that's well below the rough double-digit inflation of the 1970s, the CPI is nonetheless on the rise by recent standards. From a 6.1 percent rate in 1990, it fell to 1.6 percent in 1998, before jumping to 2.7 in 1999. Feds and other consumers have felt direct evidence of this rise in gas prices and, in some sectors of the country, housing costs.

The impact of the CPI numbers is widespread. The Social Security Administration uses it to adjust benefits payments to retirees, the private sector uses it as a bargaining chip in wage negotiations, and the Federal Reserve uses it as an indicator in deciding whether to raise or lower interest rates.

The Federal Reserve has raised interest rates several times this year partly because of the rising CPI. Initially, the effect of higher interest rates attributable to actions taken by the Fed is to raise mortgage and credit card rates — and thus further increasing the CPI. Eventually, the goal of the Fed is to slow job growth and the rate of increase in the CPI.

The CPI numbers can be somewhat misleading to consumers. That's because the CPI reflects what's happening to the cost of an average national basket of goods and services for the urban consumer. On the other hand, your personal rate of inflation may be quite different, depending on your personal basket of goods and services and where you live. For example, tuition for college has risen much faster than the CPI in recent years, hitting families hard who are trying to put kids through school.

Another example is medical expenses, which tend to hit the elderly harder than any other group. Housing costs have skyrocketed in some areas, pricing some families out of the market. (For regional CPIs and examples of how to estimate your personal inflation rate, go to the Bureau of Labor Statistics' Web site for the CPI www.bls.gov/cpihome.htm.)

Inflation is not expected to return to its double-digit rate of the 1970s. Globalization of the economy and efficiencies wrought by computers are expected to help keep inflation down. Nonetheless, even a seemingly low inflation rate can hit you pretty hard over time. It is a silent thief: It robs you and you don't even know it. Stuff $1,000 under a mattress and at 3 percent inflation, that $1,000 will buy only $744 worth of goods 10 years from now and only $554 in goods in 20 years.

How do you keep your personal inflation in check? Here are a few tips:

* Plan for it. When calculating your retirement needs, for example, be sure your savings and investing strategies consider inflation. Many financial planners use a 3 percent to 4 percent annual rate.

* Try to cut back expenses in your higher inflation areas. This might be easier to do with college tuition and housing costs (for example, go to a less expensive school, buy a less expensive home), than for something like medical expenses or groceries. Cutting back expenses is especially critical for retirees who won't be able to compensate for inflation through higher wages.

* Review your investments. A well-diversified portfolio should go a long way toward helping you through inflationary times. You might want to look at moving some of your Treasury securities into the new inflation-indexed government bonds. Stick with shorter-term bonds or shorter-term bond mutual funds to minimize fluctuations in principal. Rising interest rates usually accompany rising inflation, and rising interest rates hurt long-term bonds more than shorter-term bonds. Also, look at real estate investment trusts (REITs) because real estate tends to hedge inflation well. And don't give up on stocks. Stock markets don't like high inflation and high interest rates, but stocks still are the best long-term hedge against inflation.

Many thanks to Dennis Filangeri, a certified financial planner based in Metairie, La., and the Financial Planning Association for providing information for this article.

—Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at miltzall@starpower.net.