No! Say it isn't so! Actually, I've been saying this forever. It appears that the obvious distortions in inflation reporting have finally reached the mainstream media. Bloomberg has finally taken a stab at the issue and John Wasik does a reasonable job of superficially tackling the issue:
What U.S. Government Won't Reveal About Inflation: John Wasik
April 17 (Bloomberg) -- There's a great scene in the movie ``A Few Good Men'' in which a Navy lawyer is grilling a U.S. Marine officer played by Jack Nicholson.
``I want the truth,'' the lawyer insists. ``You can't handle the truth!'' Nicholson's character barks. I hear this dialogue in my head whenever there's a question on whether the government's Consumer Price Index, or CPI, is an honest gauge of living costs.
I'm convinced there's a much more insidious story that needs to be told as the bond and precious-metals markets gyrate daily over perceived inflation threats.
If the full impact of consumer-price increases were accounted for, investors would have a lot more to worry about, and you should prepare for a threat that's much greater than Labor Department reports indicate.
The government has a vested interest in keeping official inflation measures low. Everything from Social Security cost-of- living increases to marginal tax rates is adjusted annually to this all-important gauge.
The total cost of what we are paying for big-ticket items is much higher than what's reflected in the CPI.
Take housing costs, for example. The Bureau of Labor Statistics, or BLS, the U.S. Labor Department's agency that calculates the price index, estimates housing costs by figuring ``owners' equivalent rent,'' or a proxy of what homeowners would pay in average rent increases.
The CPI Lie
As the largest component of the CPI at 23 percent, housing represents a huge portion of the overall cost of living. Yet the Labor Department's indirect measure vastly underestimates actual housing costs since it doesn't reflect home-purchase prices, financing, maintenance or property taxes. Done any roofing, remodeling or painting lately? Have you noticed how much your property-tax bill has climbed to match higher home values?
How understated is the Labor Department's rent metric? Jim Floyd, senior analyst for Minneapolis-based Leuthold Group, an investment research firm, notes that ``since 1996, existing-home prices are up 81 percent, but the BLS owner-equivalent rent numbers are up only 30 percent over this entire period.''
``Housing is not factored into the CPI,'' says Chip Hanlon, president of Delta Global Advisors Inc., a Huntington Beach, California-based investment advisory firm. ``I've never seen a great answer as to what inflation really is.''
More Fibs
The government's housing-price figure is so low that Floyd estimates consumer inflation would be as much as 1.5 percentage points higher if actual housing costs were included in the CPI.
There's even more underaccounting on two other large household bills: medical care and college financing.
Last year, health-insurance premiums alone climbed 9 percent, according to the Kaiser Family Foundation, a research organization based in Menlo Park, California. The 2005 increase ``is still more than three times the growth in workers' earnings and 2 1/2 times the rate of inflation,'' the foundation states. U.S. consumer prices rose 3.4 percent in 2005.
Paying for college? You would have seen an almost 6 percent increase in four-year private-college costs just for the 2005- 2006 year or a 7 percent climb in a public-school bill, according to the College Board, a research and testing firm in New York.
Then there's the continued wildcard of rising energy prices. Crude oil is up about 12 percent this year. Reports this month that the U.S. is preparing an attack on Iran have helped push prices near $70 a barrel at a time when supplies are running short and world pumping capacity is peaking.
Inflation Hedges
``It's hard to argue that the average person has seen a 3 percent CPI,'' Floyd says. ``If you've had surgery, paid for college or bought a house recently, it's hard to buy even a 3.5 percent inflation rate.''
What the government is loath to admit is that you are constantly losing money in your portfolio due to inflation -- if you aren't hedged against it.
Traditional inflation bulwarks such as metals-mining stocks, bullion and rare coins offer some protection. The glaring problem is that most investors time their purchases badly and these high- risk vehicles rarely offer dividends.
Keep in mind that, even with its recent increase to $600 an ounce, gold -- the traditional inflation beater -- was in a bear market from 1981 to 2001. If you got Klondike fever in 1980 and held on to your auric investments -- as many people did when gold peaked at $847 an ounce -- you would have lost money for two decades, possibly missing an opportunity in common stocks.
Wilshire Index
Diversification clearly has its virtues. During the same period, a stake in the Dow Jones Wilshire 5000 Composite Index of more than 5,000 U.S.-listed stocks, including energy and mining shares, rose almost eightfold for a 10 percent annualized return, according to Bloomberg data.
Want to capture the overall market's gains without attempting to time it? Consider the well-diversified Vanguard Total Stock Market VIPERs (VTI), an exchange-traded fund that is a proxy for the Wilshire index.
The simplest way of hedging for general consumer-price increases is through inflation-protected securities. The U.S. Treasury packages these bonds in either Treasury Inflation Protected Securities, also known as TIPS, or in Inflation- Protected Savings Bonds, dubbed I-Bonds.
The U.S. Treasury and most brokers sell TIPS, which are Treasury bonds that pay a premium based on the consumer inflation rate. You can also buy TIPS through Treasury auctions. I-Bonds are based on the same idea, only you can buy them at any bank in denominations from $50 to $10,000. The bonds accrue interest, which is paid when you redeem them.
Dazzle of Metals
If you are prudently hedged against inflation, forget about bragging about it at a cocktail party. Index funds and inflation- protected bonds don't have the dazzle of precious metals and you are unlikely to impress your friends by telling them you bought an I-bond.
Then again, you won't be misled and financially crippled by the government's cost-of-living mythology. You can more than handle the truth by inflation-proofing your portfolio.