The Consumer Price Index (CPI) is an official government statistic that measures inflation.
Inflation expresses the rising cost of living. Governments track inflation by following a selection of goods and services around the country.
The list includes the cost of food and beverages, housing, clothing, transportation, medical care, recreation, education, communication and a host of personal expenses.
The Bureau of Labor Statistics gathers this information from people living in cities, known as the “all urban consumer group.” That covers 89 percent of the population. It extends to professionals, wage earners, retired people, the unemployed and the poor.
Economists collect data from extensive surveys of thousands of families. The families keep spending diaries over two-week periods.
The resulting statistic is “CPI.” It broadly represents the change in the purchasing power of money over time, i.e., inflation.
From the investment perspective, the Consumer Price Index is an important marker of the effectiveness of a given portfolio or investment.
If your return is greater than the annual rate of inflation, for instance, you can be assured that your purchasing power is protected in the future.
An investment that returns the same as the inflation rate means your money will buy the same good or service in the future.
Meanwhile, an investment that returns less than the inflation rate is a serious problem. Your money will become less valuable in time.
Investors seek to overcome inflation in the long run.
If inflation was permanently stuck at zero, for example, you would not need to invest. Saving alone would suffice.
The problem, of course, is that inflation is constant. Prices inevitably rise for housing, food and other goods.
Arguably, some prices fall. Technology, for instance, tends to fall in price while increasing in value. Computers today are cheaper and do more.
Other goods, such as gasoline, can rise and fall dramatically yet still end up costing more over time.
Untangling these different experiences of inflation is the goal of the Consumer Price Index.
CPI creates demand for stock investments, which tends to outpace inflation. It also affects demand for fixed-income investment such as bonds.
A bond that pays out less than the inflation rate, for instance, might see its price fall accordingly as investors seek a better return from a different bond issuer.
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