CPI measures the overall level of pricing for the goods and services that consumers buy over the month. Typically, the October number is compared both to September and the previous year’s October. CPI can be positive or negative. If the CPI is running at 2% annually, investors are losing that much purchasing power. If, however, the CPI is negative, investors are gaining purchasing power.
So, if you got a question like the following, how would you answer it?
Aunt Alice keeps her extra cash in a coffee can hidden in a secret compartment of her basement. Last year, the CPI was -1%. Therefore, which of the following is accurate?
A. Aunt Alice’s real rate of return was -1%
B. Aunt Alice’s real rate of return was 0
C. Aunt Alice’s real rate of return was +1%
D. Aunt Alice’s real rate of return was -2%
EXPLANATION: although putting money in a coffee can is not an investment, Aunt Alice got lucky last year when prices fell by 1% overall. Therefore, she is 1% above the level of pricing. The answer is . . . C.
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