Inflation 2012 and Budgeting

Before proceeding with "Part 2" of my post on "Budgeting 2012" it's useful to consider cost increases and in particular, inflation. These price changes obviously have a profound impact on one's financial planning, and one's actual expenditures. Some of the price changes are gradual. Some, however, are rapid changes. Such large swings in prices is referred to as "volatility." When prices go up and down, sometimes in large jumps, this can wreak havoc on budgets. Most businesses have forward looking plans. As a business, and in accordance with the Illinois Condominium Act, our HOA is required to. Before considering how to deal with price volatility and inflation, it's important to have some awareness of what they are and just how excessive these changes can be.

So how profound is inflation and volatility? How does it influence a typical budget, be it a personal one, or our associations? What can I do about it?

Inflation and Price Increases or Decreases, and Choice
I could use my electricity and natural gas costs as an example, or food, or other utilities. For this post, I'll use gasoline. It influences most households and certainly just about every business, and that means our contractors. Gasoline is a significant expenditure for our landscaping and snow removal contractors. It is also so for me.

Let me also state that I attempt to purchase gasoline at the lowest available prices. However, if I am in the northern Illinois area, I will purchase gasoline in the City of Wheaton. Why? Well, as I have stated in earlier posts, I attempt to "buy Wheaton" because a portion of those sales, most notably the municipal portion of taxes, goes to the city coffers to pay for some of the services I use. Of course, I am also supporting many local businesses if I purchase goods and services from establishments in Wheaton.

That decision to purchase in Wheaton does mean that I do pay higher prices for gasoline from time to time. That's an example of a personal decision, and that decision does influence how much I spend. Other personal choices and decisions influence other areas of my spending. This includes, for example, decisions pertaining to the use of cell phones versus smart phones with data lines, the setting on the home thermostat, the food I eat, the number of meals purchased in restaurants, the type of cable or satellite TV I have (none, basic, premium, etc.), the types of appliances (refrigerator type, energy star 32" TV or 60" plasma, the efficiency of my furnace and hot water heater), the use of CFL bulbs versus incandescent, and even my vacation and pets, and so on.

In a budget, while it is useful to consider inflation and to assume that prices will increase over time, it is also useful to keep track of real costs. Not all prices move together and in the same direction at the same time. Such tandem price movements do sometimes occur. But prices may vary at different rates for gasoline, other fuels (natural gas), electricity, basic foods, and insurance or other goods and services. The government and various agencies track and publish this information on a regular basis. Some of this is available in the popular media, but it is a goal of these websites to get one to support the advertisers, as is also true with newspapers and magazines. For that reason, many of the articles have sensational headlines and are long on emotion and short on facts. The writers often have a personal bias, or personal concerns and that is frequently reflected in what is written. So most of us get information that is distorted or half-truths.


Using Gasoline as an Example
Here's a chart of the cost of premium gasoline as consumed in one of my vehicles. This is not a "hypothetical example." This is the actual cost of fuel used in that vehicle, per gallon. There are nearly 500 gasoline receipts to support this chart! The chart begins in February of 2005.

The chart shows a trend line, which indicates that gasoline prices have increased at a rate of about 5.25% per year; we could call that the "average increase" or inflation in the price of gasoline, over the period of time in the chart. That's higher than the actual, government published rate of inflation over the same period. But gasoline prices have increased at a rate higher than the government published CPI-U or "inflation" numbers.

The chart  also highlights how prices can vary quite a bit above and below that trendline. It's a good example of what economists call "price volatility." These huge swings can have a large impact on one's budget and can even stress it when those "spikes" occur. In 2011, the average price I paid for gasoline increased about 31% above 2010 prices!  That is substantially higher than the average annual increase of 5.25%.

Later in this post I'll be looking more closely at the numbers behind the chart, and the dollar value of those spikes.

The huge price drop that occurred in the fall of 2008 was during the "Panic of 2008." So who says economic disasters are all bad? Premium gasoline was nearly $4.50 a gallon before the Lehman Brothers and government orchestrated financial disaster. Immediately thereafter it had decreased to less than $2.00 per gallon! So for about 2-1/2 months, prices fell until again increasing. The price of gasoline is determined by the price of oil, and a large part of that is controlled by the OPEC oil cartel, which currently prefers that a barrel of oil be priced at $100. However, consumption, which is to say "demand" also influences the price, as does anticipated consumption. Those who produce or trade in oil are willing to pay a higher price for the raw material if it is expected they will be able to sell it and the products (fuel oil, gasoline, diesel, lubricants, etc.) at a higher price; the opposite is also true:

The above chart is a useful example of the necessity of using methods such as cash savings to adjust for volatile situations, or contracts to hold prices steady, or both! Taking such protective measures is "good business practice." Individuals can't enter into contracts, so we have to rely on budgeting and saving for the future. More on that in Part 2 of the budgeting post.

The Numbers Behind the Chart
My average cost of fuel was about $2.504 per gallon in 2005, and was $3.908 per gallon in 2011. As can be seen in the chart, fuel prices peaked between April and July of 2008, decreased thereafter and began rising at about the average trendline rate, but surged or spike again in 2011, and have decreased since then.

So, while the average price increase per year was about 5.25%, the actual costs to purchase gasoline in any year was sometimes higher than expected from that average 5.25% increase. Why then use longer periods? Because we're making long term plans, and if not, we should be. We will have to deal with short term price changes, but we will also have to deal with the longer and more far reaching consequences. Every one of us expects to retire some day. That means, we will have to replace wages with pension, social security benefits and savings. It would be best to begin such planning early in life.

If we look at the price of gasoline in the most recent two years, that most recent price spike beginning in January 2011 contributed to an a change in price of 24% per year over that two year period!  This is important. So when one begins measuring, and when one ends, will have a profound impact on the data, which means the decisions made from the data. Politicians love to pick and choose data to support their positions. This is intellectually dishonest, but it does win elections. However, there is no place for politics in an HOA. Being a board member most certainly is not a popularity contest!

Here are the costs for gasoline in each of seven years, for 647 gallons of fuel per year, which was about my average annual consumption over that period. I am using a fixed quantity of gallons so that the annual cost below reflects only the changes in the price of gasoline purchased:

1. 2005 = $1,621.
2. 2006 = $1,777.
3. 2007 = $1,966.
4. 2008 = $2,097.
5. 2009 = $1,986.
6. 2010 = $1,930.
7. 2011 = $2,531.

As you can see above, the cost per year sometimes increased, sometimes decreased, and that increase or decrease was sometimes larger than the trend line increase of about 5.25% per year. So what was the annual price change as compared to the previous year?

1. 2006 = +  9.63%
2. 2007 = +10.60%
3. 2008 = +  6.68%
4. 2009 = -  5.27%
5. 2010 = -  2.83%
6. 2011 = +31.12%

What can I observe from this information?

1. Prices invariably increase over longer periods of time.
2. Such increases may come in "spikes or surges" and may not increase at a steady rate. 
3. Prices sometimes decrease for a time, but eventually continue their increase.
4. While economists might talk about "average" price increases, or inflation, the actual annual changes can be much larger!

What conclusions might I make from this information?

1. If I want to plan a budget for the future, it might be a financial mistake to use "average" numbers for determining how much that future annual gasoline bill might be. Or any bill, for that matter!
2. When planning a budget, it's necessary to take into account macro economic data (what is expected to occur with gasoline in the next 12 months, or 24 or 36?).
3. When planning a budget, it might be prudent to build a cash cushion for things that are more volatile, gasoline for example, the price of which can skyrocket for short periods. How "short" is a "short period?" It might be a year or longer! But eventually, costs will revert to a trend line. 
4. Making annual adjustments and calculations and using them to update the information can support the decision making process. 

How Much Did My Gasoline Purchases Actually Change from Year to Year?

Looking at the actual gasoline purchases, how much money am I talking about? Using gasoline expenditures for each year, 2005 to 2011, how much did I spend to purchase 600 gallons per year? I'm assuming that in each year, I would adjust my driving so it would not increase or decrease and would be the same for each year. So how much more or less did I spend each year to buy that gasoline, as compared to the previous year?

1. 2006 = +$156.08 more than in 2005, or $13.01 per month more.
2. 2007 = +$188.49 more than in 2006, or $15.71 per month more.
3. 2008 = +$131.25 more than in 2007 or $10.94 per month more.
4. 2009 = -$110.57 less than in 2008, or $9.21 per month less. 
5. 2010 = -$  56.29 less than in 2009, or $4.69 per month less.
6. 2011 = +$600.71 more than in 2010, or $50.06 per month more!

On a monthly basis, my gasoline cost in 2011 was $50 a month more, each and every month, than it was in 2010! Why such a huge difference? Well, prices had been decreasing for three years. So by 2010 we were below that "trend line" in the graph, which is the expected price at the usual increase. So if I used only one year of data, and assumed in 2010 that prices would "only" increase 5.25% in 2011, and ignored the trend line, I would have been making the erroneous assumption that prices would stay low for another year. Having access to some economic data, which includes the policies of OPEC and oil consumption figures on the planet, as well as long term prices, would have contradicted a "price decrease" assumption.

There are web sites which provide historical gasoline pricing information. These can be used to determine 5- and 10- year trend lines, from which personal decisions can be made. I've included a few sources in the notes at the conclusion of this post.

Using the Information to Plan my Gasoline Budgets

One thing of interest is that while gasoline increases were a reasonably steady rate in 2006 and 2007, that increase was lower in 2008 than in the preceding two years. In 2009 gasoline actually cost less than in 2008, and so too for 2010.

Was that a good thing? Well it did reduce my expenditure for gasoline in 2009 and 2010. Was that a time to celebrate and purchase a new iPhone? Or was it an illusion? In 2011 my gasoline expenditure was nearly $600 more than in 2010! Gasoline prices came roaring back! That $50 monthly increase certainly stressed my budget. Or did it? The extent to which it impacted my budget was influenced by my spending habits, and the budget I used.

I had some choices to make in 2008, 2009 and 2010. My gasoline expenses each month was less than for the previous year. So what did I do with that cash that wasn't spent? Did I save it for the costs next year, or did I spend it? What would happen if instead of spending it, I was rigorous in my budget and saved the difference?

So what was the monthly impact to my gasoline budget in the period 2006 to 2011? Here's how my budget would have looked, and this is how much extra I would have had to find in my budget each month, to pay for the gasoline because of those price "spikes:"

1. 2006 = $5.91 monthly over budget
2. 2007 = $7.98 monthly over budget
3. 2008 = $2.32 monthly over budget
4. 2009 = $18.42 monthly UNDER budget
5. 2010 = $13.36 monthly UNDER budget
6. 2011 = $41.64 monthly over budget. 

It looks like 2011 was a bit tough! But if I had kept to my budget plan, and cut back slightly in some areas in 2006, 2007 and 2008, I probably could have easily made up that $2.32 to $7.98 per month from other areas in my budget. If I went to the further step and saved what I didn't spend in 2009 and 2010 that could have been used in 2011. How would it have turned out? That's a personal decision, but it begins with knowing what our personal tolerance for budget problems might be. Most of us can make some adjustment to handle a monthly budget problem of $10. I do realize that this is an example and in the real budget, all costs would have to be accounted for. But some are discretionary. Vacations, for example. So these can be adjusted, and more on that in Part 2. 

What Else Could I Have Done About My Gasoline Budget?


So what strategy should I use? Could I have saved more, and should I? If we say that gasoline increases at the average price rate of 5.25% per year, then I would need to design a budget that accommodates that price increase, or save some money this year to help pay for that increase in the next. Businesses may adjust their fees annual to compensate for these increases, which are a part of the overhead of any business. Individuals don't have that option. The employed will earn whatever the employer decides is a reasonable wage for the services provided. Retirees will get whatever social security COLA increase that is determined. How businesses and individuals spend their income is a personal choice. As with most choices in life, some can end badly. There is no excuse for poor planning. There are times when we do everything right, and it doesn't turn out. The nature of wisdom is to know the difference.

So in 2006 and 2007 when gasoline prices fell, I could have adjusted my spending habits to put a bit aside for gasoline increase in 2008. So also in 2009, 2010 and so on. All I needed to do was look at the chart, and say "Prices have dropped, and they will recover at some point in the future. Prices will always increase over the long term."

So, how to go about this? That's a personal choice. I can:

1. Use the "average" price increase as a starting point. For example, in 2012 I should expect that gasoline will be about 5.25% higher than last year, if it follows the trend line in the chart. That will cost me about $10.53 a month more. (See Note 1).
2. However, I'm currently paying less for gasoline than I did during the "average" in 2011, because prices are currently lower. How much less? I'm actually spending about 5.36% less per month than I did in 2011. How much is that? About $13.09 less per month. Would it be prudent to put the amount I'm not spending aside each month? Yes, it would be! 
3. How much would be set aside if I did? About $23.62 each month ($10.53 + $13.09). This for the probable gasoline price increases expected this year that I'm currently not spending because of current lower prices.  
4. I can shop around for a gas station at a lower price. (See Note 5).
5. I can also adjust my driving habits. (Drive less, combine trips, car pool). 
6. Of course, I might already be doing these things!

What else can I do, when sudden price increases occur? 

1. If I cannot adjust my driving habits and lower my costs, then I must move money from somewhere else in my budget.
2. I can give up something else, and reduce my spending to compensate.
3. I can take money from savings. 

Conclusion

Budgeting for inflation may appear to be arduous, if one uses the gasoline example and attempts to account for each and every penny. However, there are shortcuts which can help, and there are tools. One thing that cannot be avoided is organization. I would also say that the first year of establishing a budget can be the most difficult. If one has no budget, but simply pays the bills when they arrive, or until there is no money left in the checking account, then planning for the future might be an overwhelming undertaking. If that is so for you, then you probably aren't ready for a position on the board of your HOA! On the other hand, joining your HOA's financial committee might provide you with a wonderful learning experience, and empower you in your personal finances.

Budgeting requires some flexibility to accommodate price changes. There will be more on this in "Budgeting - Part 2."

Here's something to think about. Taking on financial obligations, be it a 2-year cell phone contract, purchasing a car at 1.0% financing, a 2-year satellite TV contract, or even purchasing a condominium establishes a financial obligation. When signing those contracts, there is an assumption that earnings or earnings plus savings will be sufficient to pay for all of those purchases. Be that true or not, the bills will roll in each month until the debt is paid off. In a condominium there will be real estate taxes each year, and there will also be monthly fees. Those will be never ending until the condominium is sold. A question to ask when considering these purchases after making an honest appraisal of one's finances is "Am I mortgaging my future," which is to say, "Am I getting into debt over my head?"

Let me also state that the current economic situation is not a pleasant one. In the past few years, I have heard some say "You have it easier than I do," or "I live on fixed income" implying that others do not. There are other complaints, and I sometimes think many of the complaints of owners can be traced to general concern, great uncertainty about the future, and even fear. The truth is, we're all in this, and we are each aware of our experiences and our personal feelings. Each of us has some empathetic capacity, and every owner at BLMH has paid their dues. As a former A&M director once stated during an association meeting, we each "have skin in the game." I suggest we each honor ourselves and our fellow owners by acting in accordance with that reality.

See Part 2 of budgeting 2012 for the continuation of budgeting.


Inflation Today
So where is inflation today? According to a recent article in Morningstar, by Robert Cahagan and William Martin of American Century Investments: "Inflation has increased notably in recent years. The government’s consumer price index, or CPI, actually declined 0.34% in calendar year 2009, rose 1.64% in 2010, and is up 3.5% for the 12 months ended November, 2011..." That information is easily corroborated by US data, and is why the Social Security Administration has increased benefits by 3.6% for 2012.

So the downward economic slide may be over. Is there bad news? It's probable that price increases will occur. What does that mean for you and I? Well, it's probable that things will cost a bit more in 2012 than they did in 2011! It is useful to consider that the last period inflation was as low as it was last year, and for such a long period of time, ended in 1964!

Low Interest Rates and Stagnant Wages
Another thing to consider is that many of us are not getting a 4% income or wage increase in 2012. So that will squeeze our budgets. Can we dip into savings and take the interest earned? The banks are only offering about 0.74% on one year CDs, and a pittance on normal savings accounts. So money kept in the bank is losing at least 2% per year. All of this is planned by the government and it will keep mortgages low, so people will buy those units that are for sale at BLMH, and elsewhere. The owners at BLMH are paying a price for this government policy. It shows up in your monthly association fees. The association did not earn a normal $155 for each and every owner last year, on its savings. If the association could get a reasonable short term return on "safe" savings, your fees could be about $13 a  month lower than they currently are.

While it is easy for the politicians and the talking heads to vilify the banks, the fact is, with 30 year mortgages available at 3.25%, it is difficult to lend money with the expectation that inflation will be so very low for those 30 years! If a bank or credit union earns about 3.5% on a mortgage, which is money lent using your and my deposits, it's very difficult to pay me what I would consider reasonable interest on my deposited savings. Further, new government regulations require banks to hold more of those savings instead of lending them, and that held money doesn't earn much. So everything seems to be tilted toward very low returns on savings for everyone. In fact, we are at the point where lending at 3.5% with inflation at 3.5% is a losing proposition. If one considers that normal, "long term" inflation may be about 4.0 to 4.5%, then why should anyone lend money for 30 years at less than 4.5% ? This is something that the politicians and others like to gloss over when they make their grand statements. I say it's something to think about.

Returning to the present, it is probable that inflation will "spike" in the future. We don't know precisely when. That's my perspective as a board member. Saying this isn't about being right. It's about financial planning as a fiduciary so as to keep fees "as low as possible" as some like to say, while avoiding special assessments, and maintaining the property. Believe me, in an economic environment with some foreclosures, some delinquent owners and very, very low return on our savings, all of the factors are designed to create havoc with the finances of any HOA. So too for personal finances.

So what about inflation, and future planning? That's a darn good question!

Here is the bottom line; just about everything will cost more in the future than it does today. Is that a terrible thing? I think not, if inflation is "moderate." Why would I say that? Well, the alternatives, which include deflation or hyperinflation, are the consequence of destructive economic events. So if inflation is "moderate" that means that the economy and that includes much of the world economy, is humming along in a more or less normal fashion. No catastrophes!


Notes:

1. Determining the annual increase in gasoline prices can be difficult. In 2000 gasoline cost about $2.00 per gallon according to the Department of Energy. Currently its about $3.50 a gallon. This is in today's dollars. That's an annual price increase greater than the 5.15% annual price increase I used in this blog. If I used 6% per year, then that short fall in 2011 would not have occurred, had I saved the difference each year. On the other hand, I might have had too much in the budget each year. It's a matter of choice, as is all budgeting. 
2. According to Inflationdata.com, the average price of a gallon of gas from 1918 to the present is $2.45 in 2011 inflation adjusted dollars.
3. For a gasoline annual price calculator for your automobile, go to: http://www.csgnetwork.com/annualmpgcalc.html 
4. For gasoline price information, go to:   http://www.fueleconomy.gov/feg/gasprices/
5. For current Wheaton gasoline prices go to:  http://www.illinoisgasprices.com/Wheaton/index.aspx