Last year, the US Bureau of Labor Statistics reported that inflation was 3%, but many of us feel that things have gotten far more expensive. I feel that there are three reasons for this:
1. Perception – From a psychological standpoint, you’re going to emotionally register a price increase (i.e. as “pain”) with a stronger imprint than a price decrease (i.e. as “pleasure”). If you see gas prices jump from $3.00 per gallon to $4.00 you are going to feel that more than if it goes from $4.00 to $3.00. Everybody remembers a few years ago when oil got to $147 per barrel and we were paying the most we’ve ever paid at the pump (the same can be said during the late 70s oil embargo); I personally remember in the summer of 2008 paying $5.50 per gallon driving out to California (in fairness it was one of those places in the middle of the dessert where they gouge you). However, fewer people may remember in the late nineties when gasoline got to its lowest inflation adjusted level in recent history. I remember around 1997 paying $0.78 per gallon out here in Denver. Because price increases catch your eye and emotion, it can sometimes feel like more price increase is going on than what is actual. Adjusted for inflation we’re paying about what we did in 30 years ago in 1982.
2. The older you get, the more you remember things as if they were over a shorter period of time – When you’re in grade school, one month feels like an eternity. The older you get, the faster time goes and the easier it can be for a memory to feel like “just yesterday”. To remember buying a gallon of milk for $1.50 20 years ago will feel more recent. The same goes for movie ticket prices, candy bar prices, etc. The older you get, apart from having memory loss, the more likely it is that a person will be able to recall the price of something they bought decades ago as if it was yesterday.
3. Personal inflation rate – This is one of my favorite exercises to do with clients. If you look at the way the national average inflation rate is calculated, there are items in there that you don’t spend money on. A few years ago I had the epiphany, “When planning out a client’s retirement, why assume that their expenses will go up at just the national inflation rate?” At the time, healthcare costs were going up at nearly 10% per year. If someone isn’t spending any money on education and doesn’t plan to in their lifetime, does it really matter how much the prices for education are going up? At that point I created an algorithm to find out a client’s personal inflation rate. When you spend a few minutes figuring out what you spend money on each month, many people find that while the national inflation rate was 3%, their own inflation rate for what they spend money on is 4.38% (it’s unique for everyone). This is particularly true when someone is closer to or in retirement. What are the things you spend money on the most? Medical care services (up 3.6% in 2011), food at home (up 6% in 2011) motor fuel (up 10.3% in 2011), and clothes (up 4.6% in 2011) (Source: US Bureau of Labor Statistics). These are all things increasing in price faster than the average and drive one’s personal inflation rate up.
So the reason why it seems like prices are going up faster than 3% is because of perception, but more importantly it’s because they are for you, because your expenses are unique from how the national average is calculated.
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