The rate of inflation in the U.S. is usually measured by the Consumer Price Index, but your own personal rate of inflation may be drastically different. Understanding your personal inflation rate, and how to control it, is crucial because it's a real threat to your purchasing power and your lifestyle.
I’ve noticed a disturbing trend over the past few years: My gross income has declined but my workload has increased. I make less per patient and per hour now than I did more than five years ago.
Whether the reason is malpractice premiums, flat insurance payments, inability to increase fees and collect them, or corporate practice of medicine, one thing is certain: I’m not alone. According to the Medical Group Management Association, in 2006, physicians in my specialty reported a compensation increase of just 2.7%, compared with the inflation rate of 3.2%. We all know why we are feeling the squeeze but the question is, what can we do about it?
Inflation is a general rise in the price of goods and services in the economy. It results in a loss of purchasing power if income fails to keep up with inflation, since each dollar of income will buy less of a good or service than it did previously. Inflation is usually measured by the Consumer Price Index (CPI), which reflects the weighted average price of a basket of goods and services consumed by the average household. From 1926-2010 inflation has increased at an average rate of about 3% annually. However, there have been periods such as the 1970s and early 1980s when inflation increased by more than 10% annually.
It should be noted that these numbers deal with averages; a more appropriate measure of inflation for an individual is the personal rate of inflation. Inflation affects individuals differently, depending on individual income, geographic location, consumption of specific goods and services, and allocation to various investments.
For example, a married physician living in New York City with two college-aged children may be more sensitive to inflation due to higher housing costs, heating costs, and education expenses than a single physician living in the rural Midwest with no children. The only way to determine your personal rate of inflation is to accurately measure your yearly personal expenditures and compare that with your yearly income.
Simply put, if your personal rate of inflation exceeds your increase in income, you can always work faster, see more patients, do more procedures, or work more shifts. For incentive-based physicians, seeing more patients per hour not only increases gross income but it also increases pay-per-hour. However, at some point you reach a limit to the number of patients you can see per hour, and you increase the risk of making mistakes leading to possible malpractice lawsuits. Similarly, there comes a point where the number of days or shifts you work compromises your lifestyle.
A second way to address your personal inflation gap is to reduce your expenses by adhering to a budget. After all, do you really need heated car seats when you live in Florida? Do you need to finish the basement on your 5,000-sq.-ft. house when you have no children and $100,000 in student loans? That said, some expenses are fixed, such as mortgage payments, insurance premiums, and child-care expenses, for which expense reduction is nearly impossible.
The third option is to generate inflation-beating returns (known as real returns) from your investments. The goal is to preserve an investment portfolio’s purchasing power so that future liabilities, which increase at the rate of inflation, can be adequately met by an equal or greater increase in assets. Due to the compounding effects of inflation, there is a greater erosion of purchasing power as the time horizon lengthens.
Assuming a 3% inflation rate, your purchasing power declines by more than half in 25 years, which is well within an individual’s investment time-frame. With just a slight increase to 4%, it declines by nearly two-thirds. In other words, it would take twice as many dollars in 25 years to purchase the same goods and services as it would today assuming average inflation, and almost three times as many dollars assuming inflation rate is 4%.
Next time, I’ll talk about some investment strategies to beat inflation.
This week’s financial prescription: Take stock of your personal rate of inflation. It’s a real threat to your purchasing power and your lifestyle.