All posts by Tom Canfield

Does it look like we are on track for 2.0% annual inflation?

The Federal Reserve signaled about ten days ago that they would not be raising interest rates in the battle to lower inflation. Most pundits conclude that the Fed will cut rates at least twice in 2024. The stock market loved this news and it’s up 3% in ten days. Are the prospects for low inflation clear? The the data for the Fed’s favorite measure on inflation, Personal Consumption Expenditures less Food and Energy components was issued this morning. The last six months point to 1.9% annual rate, and the rate for the last four months aim at a 1.6% annual rate. This is much lower inflation that I last summarized three months ago.

 

Going deeper: below I display a table and the same six graphs that I’ve use to follow the trends in inflation.

 

 

====

 

The two most widely-reported measures of inflation are Seasonally-adjusted inflation and Core inflation. These and most all other measures of inflation are reported at about the two-week point in the following month.

 

Seasonally-adjusted inflation increased by 0.10% in November. The rate over the last six months aims at an annual rate of 3.1%.

 

Core inflation excludes volatile energy and food components. This is similar to the measure favored by the Federal Reserve. Inflation increased by .28% in September. The last six months aim at an annual rate of 3.2%.

 

 

Personal Consumption Expenditures (PCE) excluding Food and Energy is the measure of inflation that the Federal Reserve Board favors. It’s a chain-type index meaning the weights of components are revised during a year to more accurately reflect changes in purchasing patterns. It’s the measure reported near the end of the following month. The last six months aim at an annual rate of 1.9%. The past 12-month rate likely will decline: inflation in December and January will replace high monthly rates of a year ago.

 

 

== History of 12-month inflation ==

Full-year inflation measured by CPI-U shows that inflation for the last 12 months has been 3.1%.

 

== Producer’s Price Index ==

 

The change in producer prices will impact consumer inflation. PPI over the last six months is at a 0.1%. annual rate.

 

 

== Services ==

 

The last six months aim at an annual rate of 4.3%.

 

 

 

Conclusion: The last six months of the most widely reported measures of inflation – CPI Seasonally Adjusted – aims at 3.1% annual inflation. The Federal Reserve’s favorite measure of inflation, Personal Consumption Expenditures excluding Food and Energy is a different index in that the weights of the components are revised several times during the year to more accurately reflect consumer buying patterns. The last six months aims at 1.9% annual inflation.

Did you own enough of the Magnificent Seven this year?

I went to a talk Wednesday by Stu Hoffman, past Chief Economist at PNC. He included comments on the Magnificent Seven. I had not been following that term that’s applied to seven high-flying stocks. The story he told that bolstered the rationale as to why you should hold a broad-based index fund: the total return of the market over time is very “skewed;” relatively few stocks account for most of the total stock market gains over time. If you invest in an actively managed fund, and the fund does not hold the few stocks that dramatically outperform over time – or enough of them, the fund will trail the market as a whole. And, boy, from what Stu said, we really can see that clearly this year.

 

Stu said the Magnificent Seven had gained 50% in value this year while the balance of 493 stocks in the S&P 500 had gained 6% in value. Weighting those two results gives the 20% total gain in the stock S&P 500 Index. (The market is up 25% now. Stu obviously couldn’t update for the big market gain on Wednesday.)

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Here are the Magnificent Seven. I show their returns YTD as of Wednesday. Stu’s statement of 50% gain for these stocks this year is an understatement. The worst performer is up 50%. The arithmetic average is more than 100% – more than double in value.

 

 

I don’t have their weights of the S&P 500 on January 1 to verify how much they account for the total market gain vs. the other 493. They are 28% of the value of the market now. If they were 10% of the value of the market on January 1, these seven (1.4% of the total number of stocks in the 500) account for 40% of the total market gain for 2023: 100% gain * 10% weight = 10% weighted gain vs. 25% total weighted gain.

 

We can also get a sense of the skew in returns this year by comparing the return for an S&P 500 fund that weights the stocks it holds by their value relative to the whole to a fund that equally weights all 500 stocks in the S&P 500 – it tries to always own the same percentage value of each of the 500 stocks. The arithmatic average return for all stocks is about half that of the weighted average.

 

 

The equal weighted fund may own just 1.4% of its total value in the Seven, depending on its frequency of rebalancing such that each stock is 0.2% of the value of all stocks it holds.

 

 

Conclusion: You want to hold a broad-based fund that owns all or almost all stocks. You don’t miss out on the relatively few stocks that account for much of the total growth of the market. This argument is easy to understand this year. Seven stocks (1.4% of the total) account for perhaps 40% of the total market gain of the S&P 500 stocks for the year. If you hold an actively managed fund that misses out on the seven stocks – or holds too little of them – you’re left holding stocks that on average return much lower than the total market return; it’s almost impossible to match the return of a broad-based index funds that owns all of them in proportion to their value to the whole.

Use this sheet next year for your Recalculation of your Safe Spending Amount for 2025.

None of us could Recalculate to a real increase in our Safe Spending Amount (SSA) for the upcoming calendar year (see Chapters 2 and 9, Nest Egg Care [NEC]). Last week I displayed a detailed spreadsheet that showed the history of ten withdrawals of our SSA. This post contains a “short form” spreadsheet you can download and use for your calculations: you set up the parameters for the first year and your appropriate SSR% for all years; then you have to enter five numbers each December 1; the spreadsheet then does the calculations. You use this sheet next year to see if you have or have not earned a real increase in your Safe Spending Amount (SSA) for spending for 2025.

 

The spreadsheet is basically the same one in the post this same week last year, but I added a fourth column because none of us could calculate to a greater, real SSA this year. If we don’t calculate to a real increase next year, I’ll have to add another column.

 

We stick with this sheet until the combination of portfolio returns and increasing SSR% over time result in a real increase in our SSA. When that happens, we’ll start, in effect, a “new plan”. We no longer assume this current sequence of returns is similar to the Most Harmful sequence of returns in history. We throw away this sheet, and we start riding along a new sequence of retrurns with a simpler, two-column sheet.

 

== The spreadsheet ==

 

Last week I entered the five numbers for this year’s calculation. 1) SS COLA as the measure for inflation issued in October and 2) the 12-month returns I get from the Morningstar site on December 1 for the four components of our portfolio. The sheet then calculates the real return this year for our portfolio – the one Patti and I follow – 6.37%. The sheet also calculates that our real SSA (based on $1,000,000 starting portfolio) remains the same in real spending power for the third year: $50,500.

 

On Dec 1 (last week), I entered the appropriate numbers in the yellow boxes on year’s spreadsheet.

 

I added a fourth column for next year’s calculation. Next year I’ll enter the appropriate numbers in the five cells highlighted in yellow, and the spreadsheet will calculate our real portfolio and our SSA for 2025.

 

I’ll enter the appropriate numbers in the yellow boxes next Dec 1 (2024).

 

I also entered our age-appropriate SSR% for next year: that’s 5.50%; the spreadsheet will use that to correctly calculate to see if we have earned a real increase in our SSA. I get the correct SSR% for each future year as described in this post.

 

== How far away is a real increase? ==

 

I can calculate the real portfolio return we’d need this coming year for a real increase in our SSA: 18.7%. That’s better than I would have assumed at ther 11-month mark: we all had a good November for both stocks and bonds. But 18.7% is high – roughly triple the expected return on our portfolio based on long-run average returns. It is not totally out of question: our real return for our portfolio in 2017 was 16.6%, more then 2½ times our expected return.

 

 

 

Conclusion. In December – just after I get the 12-month returns ending November 30 from the Morningstar site – I calculate to see if Patti and I earned a real increase in our Safe Spending Amount (SSA) for the upcoming year. I showed the history of ten years of calculations in the post last week. This week I provide a simpler, short form calculation spreadsheet that shows our calculation for this year, and I set up it up for the calculation next year. You can download this spreadsheet for your calculations.

What will you pay yourself for 2024?

Yesterday I withdrew from our Investment Portfolio the amount we would safely spend throughout 2024: the same amount as last year adjusted for 3.2% inflation. This post describes my actions and the status of our portfolio right before our withdrawal for our spending. In summary, our calculated SSA is 46% greater in real spending power relative to our first withdrawal in December 2014. The spending power of our portfolio right before this tenth withdrawal is ~5% greater than it was at the start of our plan.

 

I enclose a spreadsheet that shows the history of withdrawing our calculated Safe Spending Amount (SSA; Chapter 2, Nest Egg Care [NEC]) since the start of our plan in December 2014.

 

Details:

 

== Portfolio Return for the last 12 months ==

 

The nominal return on our portfolio for the last 12 months was 9.81% and the real return was 6.37%. Image of returns. This was a lot better than I expected from my last look; our real portfolio return at the 11-month mark was -1.6%. Stocks in November were up about 9%.

 

 

I definitely like the upturn from the horrible results of last year. It may turn out that these two years are NOT the start of the most harmful sequence of return that would really deplete our portfolio. The next few years will be telling.

 

== Nine Years of History ==

 

The spreadsheet shows the history of our SSA and the status of our portfolio relative to our start in December 2014. It has one key assumption and one key highlight.

 

• The spreadsheet assumes I always withdraw our full, calculated Safe Spending Amount (SSA, Chapter 2 Nest Egg Care [NEC]). Under that assumption, our SSA has increased by 46% in real spending power over ten years.

 

Patti and I don’t withdraw that total. We were happy with our SSA when we took our first withdrawal in December 2014. I was very happy with the early increases. The three-year period 2020, 2021 and 2022 shot our real SSA from 22% better than at our start to 46% better. We aren’t geared to spend 46% more per year from our portfolio that we first did in 2015. If we had continued to take our full SSA, we’d be paying taxes on amounts that we will not spend, and that’s not a smart move.

 

• The calculation of the value of our Investment Portfolio reflects the fact that I used our Off-The-Top Reserve (NEC, Chapter 7) for our spending last year. I therefore did not withdraw from our Investment Portfolio at the end of last year: the spreadsheet shows we started on December 1, 2022 with the same Investment Portfolio that we had on November 30, 2022. We no longer have an Off-The-Top Reserve. I’m happy with our 15% mix of bonds; that’s roughly three years of insurance: I can sell those bonds and not stocks for about three years, as I did in 2023, if stocks crater again.

 

== SSA +46% ==

 

The sheet shows our SSA is $64,200, measured in the same, real spending power of December 2014. That is the unchaged from two years ago. It is 46% greater than the $44,000 at the start of our plan.

 

 

== Withdrawn: 48%. Portfolio value +4.8% ==

 

• The value of our Investment Portfolio before this year’s withdrawal is about 4.9% greater in real spending power than it was when we started in 2014. The table assumes we started with $1,000,000 Investment Portfolio in 2014. Total withdrawals for the nine years – right before this year’s withdrawal – have been $479,000. We have $1,048,100: we started with $1 million; we withdrew ~48%; we have 4.8% more than we started with.

 

 

 

Our portfolio value is well below its peak of two years ago (-17.5%), but I think it’s correct to compare it to what it was at the start of our plan.

 

== Checklist of Tasks ==

 

I enclose my checklist of tasks for this time of year. Yesterday I placed the orders in our IRAs to withdraw our RMDs. Those transactions took place at yesterday’s closing prices. 1) I sold shares to get cash for taxes to withhold; 2) I sold shares and transferred cash for some spending in 2024; 3) I transferred the balance of our RMDs as shares and held more shares in our taxable account that I’ll sell throughout 2024 for our spending.

 

 

Conclusion: I calculated our Safe Spending Amount for the upcoming year based on our 12-month returns ending November 30. Our 12-month real portfolio return was 6.4%. That matches our expected portfolio return. But because of the very poor returns in 2022, none of us who follow the steps in Nest Egg Care calculate to a real increase in our SSA this year. We all inflation-adjust last year’s amount.

 

I placed the sell order for FSKAX to get the cash to pay Federal and State taxes that I want to withhold; I sold to get cash we’ll spend in January; I transferred the balance of our RMDs as shares from our Traditional IRAs to our taxable account. I’ll sell those and other shares of FSKAX for the 11 “paychecks” that will be transferred to our checking for February through December 2024.

How simple have you made the tasks for the Executor of your Will?

I have been an Executor and Patti was an Executor and I was her helper. Both were VERY time consuming and somewhat painful processes. This site, EstateExec.com, looks to be a very useful organizational tool and says the average Executor spends over 500 hours to finalize an Estate. From my experience, that is not far off. The final Executor for the last-to-die of Patti and me does not live in Pittsburgh and has NO IDEA of the headache and time it takes to be an Executor. I decided to create files on my computer to help our final Executor. If I don’t do this and update the information periodically, I think the Executor’s tasks would be close to IMPOSSIBLE. This post shows a bit of my progress.

 

== I assume I am the last to die ==

 

There is not that much to do when the first of us – Patti or me – dies. There is A LOT to do when the last of us dies. That responsiblity falls on the Executor of our Will. Here are the steps that EstateExec lists:

 

 

My list and file folders that I have now look slightly different:

 

 

== Timeline: The first few weeks ==

 

EstateExec has a good list of steps for the first week. I modified the list and have these headings for the first week or so.

 

 

== The time sinks ==

 

I remember the two HUGE time sinks as 1) financial tracking of expenses in a format acceptable to the probate court, and 2) all the work dealing with maintaining the house and then selling it, distributing and selling other property and finally disposing of the stuff no one wants. I am going to spend time over the next several months to answer the following questions:

 

 

 

Conclusion: None of us want to think about the work task for our final Executor of our estate. No one who agrees to be an Executor thinks about what it requires unless they’ve done it before. Being an Executor takes an average of 500 hours to settle an estate and it is not a pleasant process from my experience. Anything you can do not to make the tasks simpler for your final Executor is a real gift to him/her.

 

I like EstateExec.com as a basic organizer and have started on organizing our information for our final Executor. This post shows a bit of my progress.

What real return do we need to get back to the peak of two years ago?

For much of 2023 it’s felt like we are climbing back from the market decline in 2022. We’ve fallen back a bit from August and can measure how far we are from what I judge as the market peak on November 8, 2021 –  exactly two years ago. When we look at inflation-adjusted numbers, we are down -20% from that peak for US stocks. We therefore need +25% real return from here to get back and leave that prior peak in the dust. That’s a lot. We may have a long wait.

 

Details:

 

In a prior post I showed the average time it took to recover from a major decline like we had in 2022 has been seven years. The shortest recovery was two years, and the longest was 14 years.

 

 

I prepared that chart before 2022 was complete: the real return for 2022 was -23.1%. It ranked as the sixth worst year since 1926 .

 

For the math to calculate how much we need to improve from here, I use the Dow Jones U.S. Total Market Index (Ticker DWCF). This index measures the value of all stock based on the change in price and accounting for dividends invested. The S&P 500 index that most of us follow is an index based on the change in price only. My US stock index fund, FSKAX, tries to match DWCF.

 

The numbers below show that after two years we are nominally 11% below the peak two years ago. We’ve had 11% inflation since then. The math that combines those two shows we are now 20% below that peak when I adjust for inflation. To make up that 20% decline, we need 25% real gain from here to get back to the November 2021 peak. That’s a big climb.

 

 

Conclusion. We likely feel a bit better about our portfolios than we did last year at this time. We’ve climbed. But when we adjust the numbers for inflation, we’re still down 20% from the peak value for US stocks two years ago. That means we need 25% real gain to get back and then surpass that peak. We have a lot more to climb.

I can plan for the amount and where I need to sell for our SSA for 2024.

I did my initial plan for our Safe Spending Amount for calendar 2024 the first week of August. I finalize the plan this month, and I can do that now. I have the two items of new information since August: 1) the 3.2% COLA for Social Security and the Medicare Premium tripwires that I want to avoid for our 2023 tax return.

 

This isn’t new or revised information: it is OBVIOUS that Patti and I – you, too – adjust last year’s Safe Spending Amount (SSA; see Chapter 2, Nest Egg Care [NEC]) for 3.2% inflation. We are FAR AWAY from being able to calculate to a real increase for the upcoming year. Armed with this information, I know how much securities I need to sell in a few weeks to get our 2024 spending into cash and where to sell for lowest taxes.

 

 

Tripwires will almost certainly adjust for inflation next year, but to be sure, I’ll use these as the limits of MAGI in my tax plan for my 2023 return.

 

Details:

 

I keep track of the progress of our portfolio return throughout the year. I get the return data for our four funds from Morningstar. The last two months have been stinkers. My chart for the first 11 months of my 12-month year shows about -2% real return. That’s on top of the -18.4% real return for our portfolio last year.

 

== If we just thought about this year ==

 

We clearly won’t have the returns over the last year to calculate to a real increase in our SSA. It will simply adjust for inflation. Even though the first days of November have been terrific, I can conceive of the results by the end of November changing this basic story if I only had this year to consider.

 

To earn a real increase in our SSA (I’m ignoring the fact that our Safe Spending Rate [SSR%, also Chapter 2] increases over time.), we need to earn back what we withdrew for spending in the year. Assume I withdraw $45,000 from our portfolio in December for our spending in the upcoming year. If returns that next year are such that I earn back more than $45,000 in real spending power, I am guaranteed to calculate to a greater SSA the next year. If I don’t earn back enough, I can only adjust for inflation – no real increase.

 

I have more for the next calculation for SSA than I had the prior year. Even if SSR% is unchanged, I’ll calculate to slightly greater SSA in this example.

 

I could state this differently. Assume I withdraw 4.5% as our Safe Spending Rate. If I earn back a shade more than 4.5% real return. If I do that, I am guaranteed to calculate to a real increase in our SSA.

 

 

== We also have the prior year to overcome ==

 

It’s MUCH tougher this year, since we all have to overcome the prior year as well as for the withdrawal last year. Our portfolio declined by -18.4% real return last year. Our withdrawal stayed the same in real spending power. That worked out of 6.5% of our starting portfolio value. We would need for this year 32% real portfolio return to earn back the amount to get to our prior peak portfolio value in November 2021.

 

 

We all still have BIG HILL to climb to get back on track to see a real increase in our SSA.

 

== Where to sell to get our SSA into cash ==

 

I can decide where I will get the cash for our SSA this coming year.

 

$SSA is always greater than $RMD, so I always play with our tax return to decide where I will sell the added amount I need for our SSA that results in the lowest taxes. That’s a simple task if I just think about this year, but it is more complex if I think about taxes over time, especially when just one of us is alive.

 

My tax planning for this year is fairly simple: our AGI – Adjusted Gross Income – will not be that close to a Medicare tripwire. I don’t need to jiggle – consider using my Roth – to get our cash to avoid a Medicare Tripwire. I hoard my Roth to be able to avoid a Medicare tripwire, and I don’t have to use it this year.

 

Overall, our taxes for 2023 will be lower than in 2022 because our RMD is less for 2023 than it was for 2022. This year I’m getting a greater portion of our SSA from sales of taxable securities that have a lower tax bite.

 

 

 

Conclusion: I finalize my tax plan for each year in November. It will be very similar to my first draft that I prepared the first week of August, but now I have the final details. Our SSA ­gross sales of securities that I’ll essentially withdraw from our portfolio is last year’s SSA + 3.2% for inflation. RMD is a significant part, but not all our SSA. I’ll sell the balance I need to add to our SSA from our taxable account. I can project our AGI and know that we won’t be close to a Medicare tripwire that we could otherwise avoid.

Have we licked the inflation monster?

A final data point for inflation in September was issued this morning. That was for the important chart below for Personal Consumption Expenditures less Food and Energy components. This is the measure of inflation that the Federal Reserve favors. The last six months point to 2.8% annual rate, and the rate for the last four months tracks to a 2.4% annual rate. These are the lowest rates in several years.

 

Going deeper: below I display a table and the same six graphs that I’ve use to follow the trends in inflation.

 

 

The two most widely-reported measures of inflation are Seasonally-adjusted inflation and Core inflation. These and most all other measures of inflation are reported at about the two-week point in the following month.

 

Seasonally-adjusted inflation increased by 0.40% in September. August and September were greater than the prior six months. The rate over the last six months aim at an annual rate of 3.8%.

 

 

Core inflation excludes volatile energy and food components. This is similar to the measure favored by the Federal Reserve. The last six months aim at an annual rate of 3.6%, and the last four track to 2.8% annual rate.

 

 

Personal Consumption Expenditures (PCE) excluding Food and Energy is the measure of inflation that the Federal Reserve Board favors. It’s a chain-type index meaning the weights of components are revised during a year to more accurately reflect changes in purchasing patterns. It’s the measure reported near the end of the following month. The last six months aim at an annual rate of 2.8%. The last four months aim at 2.5%. These are the lowest in several year.

 

 

== History of 12-month inflation ==

 

Full-year inflation measured by CPI-U shows that inflation for the last 12 months has been 3.7%.

 

 

== Producer’s Price Index ==

 

The change in producer prices will impact consumer inflation. PPI over the last six months is at a -2.7%. annual rate.

 

 

== Services ==

 

The last six months aim at an annual rate of 4.7%.

 

 

 

Conclusion: The last six months of the most widely reported measure of inflation – CPI Seasonally Adjusted – aims at 3.8% annual inflation. The Federal Reserve’s favorite measure of inflation, Personal Consumption Expenditures excluding Food and Energy alters the weights of the components several times during the year to more accurately reflect consumer buying patterns. The last six months aims at 2.8% annual inflation, and the last four aim at 2.5% inflation.

Is Social Security using the right index to measure inflation for retirees?

Since 1982 the Bureau of Labor Statistics (BLS) has tracked what they call an experimental index for Americans age 62 and older, CPI-E. This index weights components of inflation differently than the index that Social Security (SS) uses to calculate its annual Cost of Living Adjustment (COLA) – CPI-W. This post compares what SS COLA would be if SS used used CPI-E rather than CPI-W. In summary, COLA would have accumulated to about 1.5% more over the last ten years had SS used CPI-E rather than CPI-W. Don’t hold your breath: I do not see strong support for changing the calculation to CPI-E rather and CPI-W.

 

 

Details:

 

BLS tracks a number of inflation indices. I’ve shown several in recent months (See most recent here). SS uses a measure CPI-W (Consumer Price Index for Wages and Clerical Workers) to calculate COLA. Medicare premium tripwires announced in September and IRS tax brackets for 2024 that will be announced this month adjust based on CPI-U (Consumer Price Index for all Urban Consumers). Here’s the data for CPI-E.

 

== CPI-W and CPI-E differ ==

 

The CPI indices are based on inflation of a market basket of components – 460 of them – and a percentage weight for each component; weights for an index are updated every year or so. Each index differs in their weights of the components. CPI-E differs from CPI-W primarily by the weight of healthcare costs. It’s 11.3% weight in CPI-E and 5.6% of the weight in CPI-W. Since healthcare costs have increased faster than many other components of inflation over time, the index for CPI-E has increased faster than CPI-W.

 

Over the last 30 calendar years, CPI-E has increased more than CPI-W for 23 years. See detail on some of differences in components and a graph showing calendar year difference in inflation here.

 

SS calculates COLA based on the annual change in CPI-W for average for the July, August, and September. It then rounds the annual change to the nearest .1 percentage point. I show the calculations for COLA for the last 10 years for CPI-W, CPI-U and CPI-E:

 

 

• Even though actual COLA is rounded to the nearest .1 percentage point, it matches COLA when calculated to .01 percentage point over the past 10 years – 2.72% Compound Annual Growth Rate (CAGR).

 

• COLA using CPI-W has been greater than COLA using CPI-E in three years of the past 10 years and less than CPI-E in seven. Those three years fall in the last six.

 

• COLA over 10 years using CPI-W calculates to 2.72% CAGR. COLA calculates to 2.87% CAGR if SS had used CPI-E. That’s .15 percentage point difference per year.

 

• The .15 percentage point per year means COLA would have been 1.5% greater in 10 years had SS used CPI-E. If you started SS ten years ago and your SS next year is $30,000, it would have been $30,480 if SS had used CPI-E.

 

• CPI-W has been greater than CPI-E in three of the last six years. CPI-W calculates to greater about .1 percentage point greater COLA per year that CPI-E. If you started SS six years ago, your 2024 benefit is more because SS used CPI-W and not CPI-E.

     

     

     

    Conclusion: Every now and then I see an article stating the adjustment for inflation in Social Security benefits is not accurate for retirees. This is true when one compares the index that is used – CPI-W – vs. an index that is geared to folks over age 62 – CPI-E. Over the last 10 years, the difference in total SS benefits is about 1.5%. If you’ve received SS for 10 years and your benefit this next year is $30,000, it would have been $30,450 if the calculation had been based on CPI-E.

     

    In the last six years, it’s the reverse. CPI-W has been greater than CPI-E in three of those years. If you’ve received SS for six years, your benefit now is greater than it would be if the calculation used CPI-E.

    Why will Social Security (SS) increase by 3.2% when inflation was 3.7%?

    I’m sure you saw this news this week: SS benefits will increase by 3.2% for 2024. At the same time, the news was that 12-month inflation was 3.7%. Why the difference? This post is a refresher: SS uses a different measure of inflation than is commonly reported, and it calculates its Cost-of-Living Adjustment (COLA) differently. Over time, the SS COLA increases very closely match the more common measure of inflation. Adding up the last four years shows COLA to be a bit greater than the conventional way to look at inflation.

     

     

    Detail:

     

    == CPI-U and CPI-W ==

     

    The inflation rate commonly reported is the past 12-month rate based on the measure CPI-U (Consumer Price Index for all Urban Consumers) or CPI-U Seasonally adjusted. Over 12 months, these two are essentially the same.

     

    By law Social Security uses CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers). You find the data for the past ten years for each here. Data for a month is added roughly by the second Thursday of the following month.

     

    CPI-U and CPI-W don’t exactly track each other. The 12-month rate ending September for CPI-U Seasonally adjusted was 3.69%. The 12-month rate for CPI-W was 3.56%.

     

     

    == The math for COLA ==

     

    SS calculates the increase in COLA using the increase over the average of three months in Q3 of each year: July, August, and September. For this year, it averaged the index for those three months for 2023 and compared that to the average of those months for 2022. That average – 3.20% – is less than if it had used just the 12-months ending in September – 3.56% – because the 12-month rates for July and August were lower.

     

     

    If SS had used CPI-U in its calculation, COLA would have been greater for this year but less in prior three years and for the past four years.

     

     

     

    Conclusion: Social Security uses the average inflation increase over the three months in the third quarter in the calendar year to calculate the Cost-of-Living Adjustment (COLA) in benefits for the upcoming calendar year. This year, its measure of inflation, CPI-W, resulted in less COLA than the 12-month rate of inflation for the more commonly used CPI-U measure of inflation.

     

    Over time, the COLA increases should be almost identical if it had used CPI-U; over the past four years, CPI-W has resulted in greater COLA than if the calculation used CPI-U.