Should those three months happen to witness a large but temporary gain or drop in consumer prices, the SSA COLA would affect payments for a full year, starting in January, as if the temporary event had been long-lasting. In 1986, for example, the prices of oil and gas were plunging when the COLA was computed. In 1987, although energy prices stabilized and inflation quickly returned to its previous level, retirees were stuck for the full year with SSA benefits set at a lower level because of the earlier, temporary downdraft. Of course, it can work the other way, too. A temporary uptick in the CPI when the COLA is computed can give retirees a nice benefits for 12 sweet months the next year.
There are better alternatives. But they are not the ones most often cited by commentators, which were covered in the first post in this series. Have a look at the chart below. It shows the SSA COLAs since 1975 (green dots), the full CPI-U index (blue line), and two alternatives for computing COLAs.*
- Core is a measure that's been computed for decades as an alternative to the full CPI-U. It uses the same data, but leaves out Food and Energy. If domestic gas, home heating oil, or imported food should rise of fall temporarily, the full CPI-U will follow along, but the "core" inflation index won't. Wait a minute! Don't retirees have gas stoves, drive cars or take buses that use gasoline, and buy foods that may have volatile prices? Of course they do. That's why the CPI-E index ("E" is for "elderly") includes Food and Energy, in portions calibrated to the spending habits of older households. But because it includes them, the CPI-E has the same flaw evident in the chart for the SSA COLA. Any index the includes Energy is prone to the boom-and-bust cycle of the gas and oil business. Possibly, some Foods have the same failing, especially if they are imported and subject to foreign currency rates. Omitting Food and Energy from an inflation index simply removes troublesome volatility.
- Trimmed is another measure derived from the CPI-U. Like the Core index, it omits certain items from the calculation. Of the 40-plus items in the CPI-U, the "trimmed" index omits the 3 or 4 that showed the highest inflation in a given month, and the 3 or 4 that had the lowest inflation. If gasoline prices surged or collapsed in a given month, they are omitted. The same goes for utility bills or medical services or food away from home or any other component of CPI-U. The method is agnostic, however, about what to drop. Unlike the core inflation index, which always drops the same items, the trimmed index zeroes in on the current offenders, whatever they may be.
The smoothness of the two alternative measures is important for another reason. It makes the trend of cost-of-living adjustments more predictable for retirees. This year's COLA is more like next year's inflation. In the historical chart, the 0% SSA COLAs in 2009, 2010, and 2015 would have been small but non-zero values, had the trimmed or core index been used. Conversely, the spike to nearly 6% for the SSA COLA in 2008 would have been a more normal value between 2% and 4% with the other two indexes.
What Really Matters
- Will I be able to live within my budget next year?
- Will my COLA this year be like it was last year?
- Over my retirement years, will my SSA benefits truly keep up with inflation?