Author Topic: Factoring inflation?  (Read 1084 times)

PropJoe

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Factoring inflation?
« on: May 01, 2018, 06:06:41 AM »
Hi all, when calculating my FI numbers, I'm always a bit confused when it comes to inflation. Should we include it or not, what is the best approach?

A simple example, say Dave spends 20k a year and is a firm believer in the 4% rule - so he targets an FI pot of 500k.
Based on the amount he is saving each year, he reckons he can reach FI in 5 years.
Assuming a 3% rate of inflation: in 5 years time, his spending is now 23,185 - so now he needs a pot of 579,637 ?

Even though his investments are also benefiting from inflation; since he is still accumulating, after 5 years his spending would have grown faster than his pot (relatively) and he would have a deficit?
I don't think I explained that very well, but hopefully somebody smart gets my point and can offer some wisdom.

My understanding is that after FI, then inflation would sort of cancel itself out but whilst still in the accumulation phase - I'm slightly confused.

Thanks in advance!

cerat0n1a

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Re: Factoring inflation?
« Reply #1 on: May 01, 2018, 06:47:19 AM »
Hi all, when calculating my FI numbers, I'm always a bit confused when it comes to inflation. Should we include it or not, what is the best approach?

A simple example, say Dave spends 20k a year and is a firm believer in the 4% rule - so he targets an FI pot of 500k.
Based on the amount he is saving each year, he reckons he can reach FI in 5 years.
Assuming a 3% rate of inflation: in 5 years time, his spending is now 23,185 - so now he needs a pot of 579,637 ?

Even though his investments are also benefiting from inflation; since he is still accumulating, after 5 years his spending would have grown faster than his pot (relatively) and he would have a deficit?
I don't think I explained that very well, but hopefully somebody smart gets my point and can offer some wisdom.

My understanding is that after FI, then inflation would sort of cancel itself out but whilst still in the accumulation phase - I'm slightly confused.

The 4% "rule" assumes that you're going to increase your withdrawal from the initial amount in line with inflation, which is your "cancel itself out" I think.

So your question is - do I need to take into account of inflation when working out how much I need to FI and how long it will take? The answer is probably, yes, you need to make some estimate for future inflation, future investment growth, future payrises, and adjust as you go.

never give up

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Re: Factoring inflation?
« Reply #2 on: May 01, 2018, 10:10:28 AM »
Yep I'm afraid so. I struggled with this when I first joined the site and tried to come up with an annual expenditure based on future prices, so that my FIRE total took this into account. It was too difficult. I failed spectacularly.

Instead I now have a FIRE total based on today's prices. I am tracking everything I spend by category so that I can work out my own personal inflation rate. I think any government statistic or average is likely to be misleading here especially when extrapolated over numerous years. After two or three years of doing this I feel I will have as strong a grasp of my own personal inflation rate as possible, and I will use this figure to project what my FIRE pot needs to be.

That's how I'm doing it, but I'm definitely not the smart person you're looking for so hopefully someone else will be along to offer some wisdom shortly!

rob/d

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Re: Factoring inflation?
« Reply #3 on: May 02, 2018, 01:01:56 AM »
 Hello joe.
 Confusing isn't it .
The problem i have with the 4% rule is that it assumes you want to keep your stash forever.
One day i will die and i don't want/need a single penny left when i do .
 You however may want to leave something behind . Is this in your maths ? Tricky isn't it.
 Will i still own a house ? Doubt it .Will you ?
Also inflations a frikin nightmare when you add 20+ years to your annual spending calcs , but will you really  be splurging 40k a year at 80 years old if you used to live on 20K a  few decades ago ?
Do your best to figure out YOUR number , use a calculator like this one .
What i'm saying is the 4% rule is great for most people , but not as relevent to some .

https://financialmentor.com/calculator/best-retirement-calculator


PhilB

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Re: Factoring inflation?
« Reply #4 on: May 02, 2018, 04:25:49 AM »
IMO the only sensible way to proceed is to do all your calculations in today's money and to use a post-inflation figure for investment growth.  If you try and include inflation explicitly instead, not only are the calculations more complicated, but the answers don't make any sense until you convert them back to today's money by taking inflation back out again.  You just need to remember to upgrade your spreadsheet for inflation one a year or so to ensure that it stays in today's money rather than becoming yesterday's.

PhilB

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Re: Factoring inflation?
« Reply #5 on: May 02, 2018, 04:30:31 AM »
....
The problem i have with the 4% rule is that it assumes you want to keep your stash forever.
One day i will die and i don't want/need a single penny left when i do .
 ....
https://financialmentor.com/calculator/best-retirement-calculator
Not true.  The 4% rule is all about having a minimal probability of it running out over a set period (30 years in the original studies).  The fact that most people would, historically, have ended up with more than they started with is merely a side effect of that, not an aim in itself.

Other than by buying an annuity you can't plan to spend down to nothing unless you have a firm date for when you are going to die.

PropJoe

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Re: Factoring inflation?
« Reply #6 on: May 02, 2018, 06:10:08 AM »
Yeah I do get the point that inflation is different for different people.
For example, my biggest expense is my mortgage and this is currently fixed so not affected by inflation. My spending has definitely not increased as much as inflation, in fact it's been decreasing as I've become more mustachian. However, I'm not tracking my expenditure well enough (or for long enough) to have a view on my personal inflation rate. I hope to get there one day.

I'm slightly risk adverse so don't really want to see my pot dwindling in retirement. I think I'll take closer to 3% but will be flexible on that dependent on life circumstances and market conditions. Hopefully, I'll see my pot still increasing in retirement which will give me even more contingency and the ability to help the kids out more with uni, houses etc
As you say, there are so many variables - I was just wondering how everyone else approaches the maths. Thanks for all the responses so far.

rob/d

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Re: Factoring inflation?
« Reply #7 on: May 02, 2018, 08:34:19 AM »
 True phil , i don't know when i will blink out .
 Who does ?
 I know i won't get to 100 years old , guaranteed .
 So the calcs for myself includes revenue streams which are inflation tracking and
 makes up  part of my income now . You guessed that bit right.
 This is a figure i could survive on and that will never cease.
 Other income is from my stash  based on a safe withdrawal rate  now but with an eye on running it  down to zero from  state pension age.
 I like the 4% rule , i really do , but i also factor in pensions and fixed incomes . Eventually just pensions.
It's a plan that took effort to work out and allocate properly , and will  change as i go along .
I can see Propjoe doesn't mind leaving a stash behind , opposite to my situation i.e no heirs.
That in itself makes it much easier to work out , you can only work it out wrong one way, as opposed to two ways for me.


 

PhilB

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Re: Factoring inflation?
« Reply #8 on: May 03, 2018, 02:25:57 AM »
True phil , i don't know when i will blink out .
 Who does ?
 I know i won't get to 100 years old , guaranteed .
 So the calcs for myself includes revenue streams which are inflation tracking and
 makes up  part of my income now . You guessed that bit right.
 This is a figure i could survive on and that will never cease.
 Other income is from my stash  based on a safe withdrawal rate  now but with an eye on running it  down to zero from  state pension age.
 I like the 4% rule , i really do , but i also factor in pensions and fixed incomes . Eventually just pensions.
It's a plan that took effort to work out and allocate properly , and will  change as i go along .
I can see Propjoe doesn't mind leaving a stash behind , opposite to my situation i.e no heirs.
That in itself makes it much easier to work out , you can only work it out wrong one way, as opposed to two ways for me.
Pensions and suchlike do really complicate the maths - unless you are lucky enough that accrued DB and state pensions will be enough for you so the stash only has to last until they kick in.  I get almost jealous of the those doing it entirely on the stash who just work on 25x spending = enough.  We will have various pensions kicking in between 11 and 16 years post our FIRE date so part of the stash backfills for them and the rest is planned as a perpetual drawdown.  Much juggling of numbers required.