Accounting for inflation in retirement planning (Australia)

[Wadiman]

Hi -

I'm sure this subject has been discussed many times directly and indirectly but after having read through a number of posts I'm after some succinct advice.  I'm also a bit challenged here with the mathematical assumptions so bear with me.

In working through my FI strategy I have determined my annual expected spend as at year 1 retirement (6 years from now) based on today's dollars ($55k). 

My question is - how do I take into account the actual amount that I will need six years from now in my planning spreadsheet?

Should I simply inflate my expected annual spend (ie $55,000 * 1.03^6 = $65,673 in excel speak for the first year of retirement and apply same inflation factor each year) assuming an average inflation rate of 3% based on recent actual inflation in Australia?  I have assumed 8% total rate of return pa.

Thanks!

[bigchrisb]

I find estimating inflation is pretty tricky.  To boot, over retirement planning timeframes (50+ years when including pre FIRE and post FIRE), the assumptions make a monstrous difference.

My own approach has been that I'll be using dividends to fund my lifestyle post FIRE, potentially with a bit of rent from commercial and residential property.  My long term assumption is that capital growth and dividend/rent growth will increase with inflation (no more). With the usual past data and future prediction caveat, this seems to have held over most time periods.  Hence, if I'm getting enough current income out of cash flow from rents and dividends, I should be compensated for inflation.

To boot, because I'm a conservative engineer, I actually want to be reinvesting some of the cash flow from investments - this becomes extra lifestyle growth down the track if all goes to plan, or if needs be I can save less of this if rents/dividends fall.   My current target is to have a dividend/rent cash flow that is double my annual expenses.

In terms of theory, your indexation of 1.03^6 seems OK.

[marty998]

Inflation is actually currently running quite a bit lower than 3% right now.

I wouldn't worry too much about it to be honest. Properly invested, your assets should grow much faster than inflation anyway.

[Wadiman]

Thanks for your thoughts Chris and Marty.

I'll work up a post in the case study section, attach a spreadsheet and invite comments.

[Retired To Win]

I may be naive, but I am proceeding on the assumption that any increase in living costs caused by inflation will be matched by an increase in my passive (dividend and inflation-indexed annuity) income.  So I am shrugging off factoring inflation in.

[arebelspy]

Inflation is the #1 danger to an early retiree, much more so than market crashes. You are right to be considering it.

It's well worth educating yourself about, IMO, and coming up with a plan for it (and/or making sure your AA accounts for it via hedges).

[deborah]

Certainly in the last period when we had high inflation, some things kept up and some didn't. For instance, while inflation may have been at 16%, rents were only going up annually (if at all) for people renting (I rented for a number of years before I bought a house at the peak of inflation, and only remember my rent going up once). On the other hand shares followed inflation up (in general). So at that time, it would have been OK to not worry about allowing for inflation if you had shares, but you would have been in big trouble with either cash or depending upon rents from investment property.

However, I think that everything is a bit uncertain. As I develop my frugality, I change what I spend each year. If I was still saving towards retirement, I would be saving more because of this. Your spreadsheet is not going to account for this developing frugality. You ay even change what is important to you as a result. So your retirement may also look completely different and require a different amount of money to what you are currently thinking of needing.