Can I hedge my household expenses using the financial markets?

Question

Apparently farmers can hedge against high raw material prices and low crop prices by using financial instruments such as forwards and futures. Can I use financial instruments to similarly hedge my household expenses against unfavorable prices? A stable cost of living would be nice to have. Things I would like to hedge:

• Housing costs (rent)
• Utility costs (electricity, water, natural gas, telecommunications)
• Gasoline/petrol costs
• Food and beverage costs
• Other consumer staple costs (e.g. laundry detergent, toothpaste, replacement light bulbs, dishwashing liquid, etc.)

Can I enter into forward or futures contracts to hedge against increases in household expenses? If so, how? Is it a good idea?

Answer 1

You don't consume enough of any one good to make hedging with futures economical.

I'll present an alternate method - you hedge against risk in household expenses by setting a budget and sticking to it. You may not be able to fully control the cost of toothpaste, but you can set an overall budget that includes some discretionary items, and adjust if prices rise unexpectedly. If the price of toothpaste goes up, then you spend a little less on food by choosing less expensive options. Or perhaps the price of gas goes down at the same time (for some unrelated reason) and it "evens out in the wash". If the price of cars goes up, you adjust your budget or find a cheaper car. If your rent goes up, adjust your budget or find a cheaper place to live (or buy a house with a fixed-rate mortgage).

I would also say that your income probably provides part of a hedge since it should increase over time (not necessarily exactly with inflation, but possibly in large jumps every year or two).

Your situation is much different from the wheat farmer that has significant risk in one source of income. Your situation poses multiple expenses that only need to be hedged in the aggregate, so you can reduce risk by adapting when prices change.

Answer 2

The largest personal cost you have is probably housing - and you can hedge the risk of real estate fluctuations without use of financial instruments. ie: you can buy your home. You might not consider this 'using the financial markets', but if your goal is actual just 'a stable cost of living' as you say, then this can help with that.

Of course, it adds on the risk of variable house maintenance costs, and adds on costs associated with moving [particularly closing costs, which can be significant especially if you move more frequently than 5 years after you buy a house]. For this reason, this adds stability only to the extent your job is stable, because loss of income down the road might require you to either downsize or move. The smaller your mortgage is, however, the more flexible you become, because you won't run the risk of being underwater and unable to pay off the mortgage by selling in the event of a 2008-style downturn.

If you are unable to secure a completely fixed-rate mortgage, then purchasing a home with debt will also cause you to suffer interest rate risk, so your total cost of ownership would not be perfectly hedged. The risk of rising interest rates would need to be weighed against the risk of rising real estate / rental prices [keeping in mind that, all else being equal, rising interest rates will likely also raise rent prices, in general].

You could try to mitigate these 'administrative' problems by accessing the financial markets while still renting, by buying Real Estate Investment Trust units, which are effectively shares in property ownership companies. Focus in on companies that rent in your jurisdiction, and if your rent personally goes up, your REIT income should also go up. Of course, the direct correlation between the two could be quite variable. Note that jurisdictions with mandated rent controls, or limitations on rental price increases, may reduce the risk that your rent in 25 years becomes unaffordable for you relative to a consistent income stream.

Your other items listed have similar answers, though none quite as significant as this single decision of home ownership. In effect, buying instead of renting fixes market-price fluctuation costs, and that would also apply to a car, investment in a home kitchen rather than buying takeout, etc. etc. etc. You could even put solar panels up to mitigate the risk of utility cost overruns, but that often takes a long time to pay off and is very jurisdiction dependent.

Answer 3

In theory (but not practical in reality), you could hedge each of those expenses with various inflation swaps, futures, and other OTC products.

• Housing costs can be hedged by exposing to REITs returns through LEAP Call options
• Utility costs can be hedged by exposure to natural gas futures and call options on utility companies.
• Gas can be hedged using an oil future contract
• Food and beverage costs can be hedged using futures on pork belly, orange juice futures, and other agricultural commodities.
• Other consumer staples can be hedged with inflation swaps.

While it is possible to implement a hedge, it would not result in perfect replication. The high transaction costs to implement this would make it not feasible.

Answer 4

If your costs are in US dollars, I-Bonds adjust yield and TIPS adjust principal periodically using the US government's CPI-U measure of consumer price inflation, including food and energy.

Whether the CPI-U national aggregate average market basket corresponds well with yours is a separate question to review.

Answer 5

Yep... you could buy in bulk. If you think the price of toothpaste will go up in the next week, bulk buy 50 tubes now. If they go up, you've won, if they stay the same, you haven't lost anything. Household goods like that don't usually drop in value, so it'd be hard to lose, but they do go on sale, so buy in bulk when there is a sale or from a wholesale store.

You also introduce additional risk, i.e. spoilage / theft / fire, etc. And you'll need some decent storage space.

Answer 6

There's no futures market for most retail consumer products to support individuals hedging.

As others have mentioned, housing is one of the biggest expenses you have, so buying a home or having a long-term lease is a way of stabilizing this cost.

Utilities may offer long-term contracts. This gives you predictable expenses now, but you could get a shock when the contract runs out and the price jumps. However, if it's a service with competition, you may be able to get them to give you the same or a similar price if you threaten to switch.

For day-to-day purchases, probably the only thing that comes close is buying in bulk from stores like Costco. When prices are low, stock up on toilet paper and toothpaste.

Answer 7

Not really.

Even if you tried, the vig would eat you alive as the scale is too small for your purpose.

You would do better just gambling on stocks or options with big amounts that would, assuming you actually win, more than pay for the commissions fees and research.