One of my very favorite personal finance metrics to calculate, monitor, and compete against is my personal inflation rate (as one half of a married couple, it could more rightfully be referred to as “household inflation rate” since my wife and I share all costs). Whatever you want to call it, I’d put it second just behind personal savings rate and ahead of safe withdrawal rate, crossover point, net worth (or the preferable “usable net worth” I take credit for inventing) as a top personal finance metric.
What is personal inflation rate? Well, I’m sure you’re familiar with the concept of price inflation, so let’s start there. When consumer prices go up over time, you have inflation. Of course, prices don’t always have to go up – they could go down as well. When prices decline, you have deflation.
The government keeps a close eye on inflation/deflation as a key economic health measurement using the Consumer Price Index, or CPI. CPI measures the prices of all goods and services, minus energy and food (which is highly dependent on energy), due to their volatile price fluctuations.
CPI is calculated by taking the current price of goods and services and dividing it by the previous price of goods and services (often current month, quarter, or year divided by the previous month, quarter, or year).
In recent years, the Federal Reserve has aimed for an annual CPI inflation rate of 2%, and they have used things such as altering the Federal Funds rate to try to achieve this ideal benchmark.
Things don’t always go so smoothly. For example, when there are energy commodity shortages and demand exceeds supply, it can quickly drive up the price of energy, which increases the price of everything else and leads to higher inflation (even if energy isn’t included in the index). Occasionally, things can go the other way, and weak demand and over-supply can lead to deflation, which is viewed as a troublesome economic indicator.
Personal inflation rate is taking the CPI economic concept and applying it to your personal expenses for goods and services (including energy and food).
I’d recommend that you calculate your personal inflation rate using the following equation:
Personal inflation rate = cost of all personal expenses in most recent year/cost of all personal expenses in year prior
Here’s an example in action:
- Your 2019 expenses totaled $51,000
- Your 2018 expenses totaled $50,000
- Your personal inflation rate = $51,000/$50,000 = 1.02 (or, 2%)
Pretty simple, right?
To make it even simpler and drill down further to see exactly where your personal inflation is coming from, I’ve gone ahead and created a personal inflation rate calculator and spreadsheet for you. Just plug in the annual expense numbers, and the spreadsheet will calculate your personal inflation rate for you. You must log in to your Google account, select ‘File’, and ‘Make a Copy’ in order to edit. If you prefer an offline Excel (.xlsx) or .ods spreadsheet, you can also select ‘File’ and ‘Download As’ to download those formats.
Or, you could plug in some added columns and formulas to the free budget spreadsheet I shared previously.
Here’s an example of what the calculator looks like in action (image to right):
Having a total number is useful, but I find that the most beneficial exercise is finding out where price increases or decreases are coming from, which is why I broke out expenses by line item.
You can expect 0% inflation in many key areas:
- life insurance
- auto loans/leases
Where things get interesting are in areas that are representative of your consumption:
- dining out expenses
- utilities (gas, electric, water)
- other miscellaneous
And some recurring expense categories can sneakily grow quickly on you:
- mobile phone plan
- home insurance
- auto insurance
Using Personal Inflation Rate as a Lifestyle Inflation Killer
I do this personal inflation rate exercise annually because it helps me keep track of my consumption habits at a granular level and notice the long-term trends.
If you’re not careful, the insurance, grocery, dining out, travel, entertainment, and miscellaneous categories can really sneak up on you and lead to lifestyle inflation, or lifestyle creep, as your income grows.
Monitoring personal inflation rate and remedying the high inflation areas can limit lifestyle inflation. And that’s why it is one of my favorite personal finance metrics – it gives you granular insight into your expenses (which is one half of the equation to growing your savings).
What is a good personal inflation rate? It depends. If you have a high spend level, any sort of personal inflation should be considered a negative. You want deflation in your spending, not inflation. Once you get your spending under control and optimize it to beneficial levels, I would aim for 2% inflation or less (particularly in a low inflation macroeconomic environment like we have right now).
- To Build Wealth, you Must Defy Status Quo
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- The U.S. Personal Savings Rate
- Wants vs. Needs Budgeting
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