TRUCKEE, Calif. - One of the points of discussion in the ongoing fiscal cliff talks has been the use of "chained CPI" to calculate the annual increase in social security payments. CPI stands for the Consumer Price Index and is a measure of inflation.Inflation can be one of the most destructive forces for an economy. Severe cases of inflation are known as hyper-inflation. In one of the worst cases of inflation, in Zimbabwe in 2008, prices were doubling every 24 hours.The use of the chained CPI calculation could save the government about $100 billion over the next ten years in social security payments. The effect would be to reduce the increase in payments over time.The chained CPI assumes that in an inflationary period, consumers will adjust by purchasing less expensive items. If chained CPI is adopted, it will hurt people who depend on their social security income.Investors need to be aware of how inflation can affect their portfolios and their long term investment goals. Inflation has averaged about 3 percent for a long period of time. One thing that means to investors is that you'll need to get an after tax return of at least 3 percent just to maintain your purchasing power. If you're a retiree you'll need to be able to increase your income by about 3 percent per year to stay even.People who are doing some financial planning also need to be very cautious using the CPI in their inflation calculations; it might be worth examining your own personal budget to see how much the items you purchase are increasing in price.The method used to calculate the CPI was changed in the early 1990's and the result is that it may very well be understating inflation. One example is gasoline - if gas prices are rising rapidly, they average the data and smooth it out, so that rising prices are never fully reflected in the headline inflation number. If gas prices are falling, they don't make an adjustment, so falling prices will have the impact of lowering the headline inflation number. If the old method of calculating the CPI were still in effect today, inflation would be closer to 10 percent.One strategy investors can use is to invest directly in the products that hurt them the most when prices increase. Using exchange traded funds; investors can own oil, gasoline and agricultural products. That way, the pain of rising prices at the store can be offset by gains in your investment account.Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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