19

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?

  • What currency or location is this for? If your costs are in US dollars, I-Bonds adjust yield and TIPS adjust principal periodically using the US governent's CPI-U measure of consumer price inflation, including food and energy. – user662852 Sep 24 at 14:58
  • 4
    Note that investments always carry risks, but the point of hedging is to reduce risk. If the net risk goes up, you miss the point of hedging. – PyRulez Sep 24 at 15:58
  • 6
    So... you want to buy in bulk? – corsiKa Sep 24 at 16:47
  • 1
    Buy a house with a fixed rate mortgage and let the bank take the inflation risk. Otherwise, here is a link: alliancebernstein.com/CmsObjectABD/PDF/Research_WhitePaper/… . – S Spring Sep 25 at 9:46
39

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.

| improve this answer | |
  • 1
    A broader point would be that since the goal is wanting to hedge cost of living 'in the aggregate', a diversified investment in the retail economy provides some natural hedge against price increases. As with income providing a hedge, which you mention, stable participation on the income side of the economy somewhat hedges you against risks in the expense side of the economy. – Grade 'Eh' Bacon Sep 24 at 14:39
  • 4
    Actually you can, in some instances. For instance, a friend with a large house in New England routinely does a "futures" contract on her heating oil every summer. And an annual lease rather than month-to-month rent would be a hedge against rent increases. But with most things, the only hedge is to buy the large economy size (why I missed out on the coronavirus toilet paper shortage :-)), or buy a bunch when it's on sale. – jamesqf Sep 24 at 16:24
  • @jamesqf: If you buy the large economy size of everything, then (assuming you live somewhere space costs money and didn't just build a cheap storage shack in the woods for it) you already took a net loss paying for more living space than you need and spending a significant part of it on storage. – R.. GitHub STOP HELPING ICE Sep 25 at 19:39
  • @R..GitHubSTOPHELPINGICE or you got rid of the TV and all the networks saving money and spend your evenings looking at your noodle packs... – Frank Hopkins Sep 26 at 2:12
  • @R.. GitHub STOP HELPING ICE: Obviously there are reasonable limits, e.g. the cupboards under my bathroom sink are plenty large enough for the large economy size package of toilet paper. It's not like I was one of those people hoarding multiple packages. As for the net loss, it's much easier to sell a 3-5 bedroom house where I live than one with only 1 or 2 bedrooms. – jamesqf Sep 26 at 4:12
11

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.

| improve this answer | |
  • 3
    But Aleph, buying a house has "costs": but any hedge or investment has "costs". The fact is the only way to "hedge" housing costs is .. buy one. That is true whether mortgage rates are 1% or 20%, and indeed it is true whether you buy for cash or with a mortgage. Because then you're on the other side of "housing price changes". – Fattie Sep 24 at 15:08
  • 3
    @alephzero The addition of paying interest on top of your housing increases your total cost, but it does not impact the hedge against fluctuating real estate costs. If you are unable to have a fixed interest rate for the full term of the mortgage however, you also introduce interest rate risk into the equation. All of these are separate items that need to be independently viewed and then consolidated into an overall 'does this make financial sense' perspective. – Grade 'Eh' Bacon Sep 24 at 15:23
  • 4
    "If you take out a loan, you are exposed to changes of interest rates" How? If you have a fixed rate loan and the interest changes, how does that affect you? It only affects you if you choose to sell the house or refinance. – D Stanley Sep 24 at 16:38
  • 2
    @SteveCox But that's the difference in cost, not risk. If you have a fixed rate mortgage, yes you have to pay the bank to absorb that risk, but that's different from you actually suffering the risk yourself. You know exactly what you pay, in advance - no risk for you, just for the bank. – Grade 'Eh' Bacon Sep 25 at 18:51
  • 1
    @Grade'Eh'Bacon Exactly - there may be an opportunity cost, but the same cost could happen to the farmer that hedges. The point of fixing your rate is so you kniw exactly what rate you'll pay for the life of the loan (or until you sell/refinance). – D Stanley Sep 25 at 20:46
9

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.

| improve this answer | |
  • 9
    It's nonsensical to suggest an everyday retail consumer should be using futures contracts to hedge his cost of living. – Bob Baerker Sep 24 at 10:33
  • 9
    The correlation of the instruments mentioned vs the impact to the retail consumer is highly suspect - even equating gasoline prices to oil futures contracts, which you might say is the 'purest' commodity you use on a daily basis, leaves out costs of refining and distribution that might differ by 20-50% compared with oil future price volatility, depending on how far your region is from one of the oil future contracts you could buy. This isn't just an administrative cost question, the correlation itself is in question. – Grade 'Eh' Bacon Sep 24 at 14:36
  • 1
    I wonder if there it an ETF designed for this. That would be neat! – PyRulez Sep 24 at 15:53
  • @Grade'Eh'Bacon That is why I stated it would not result in perfect replication because of the correlation factors. – Jake Freeman Sep 24 at 16:45
  • @JakeFreeman Your answer doesn't mention correlation as an issue, just transaction costs. – Grade 'Eh' Bacon Sep 24 at 17:24
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.

| improve this answer | |
3

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.

| improve this answer | |
  • Buying in bulk makes sense but not so much with 50 tubes of toothpaste, unless you have 15 kids and a TV show.. Expiration date? – Bob Baerker Sep 24 at 15:43
  • @BobBaerker It's been 19 kids and a tv show for a few years now. – psaxton Sep 24 at 21:48
  • My apologies for not paying attention to reality TV :->) – Bob Baerker Sep 24 at 22:53
  • @BobBaerker Toothpaste lasts for several years, expiration dates are just a legal requirement. 1 tube a month - 50 tubes = a little over 4 years – Cloud Sep 25 at 9:08
  • @Cloud - Toothpaste has about a 2 year expiration date, assuming that it hasn't been stored while pending sufficient sales to reach the store's shelf. Expiration dates are NOT just a legal requirement. Chemical compounds deteriorate, albeit at different rates. If you wanted to make a proper case, you'd cite the 1/2 life and offer that it would be less effective at 4 years. An extreme example would be precision meds. Imagine your pharmacist saying, "Oh it's quite alright Mrs. Jones, you can take that insulin that expired 10 years ago. Expiration dates are just a legal requirement." – Bob Baerker Sep 25 at 13:27
2

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.

| improve this answer | |
  • It's an outstanding point that simply "stocking up in bulk when an item is low priced" is probably the closest to what the OP is asking. – Fattie Sep 24 at 15:06
0

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.

| improve this answer | |

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.