How does a country's inflation affect SWR?

[neonlight]

Malaysia has an average inflation of 3.5%, that's about double US's rate.

The common wisdom here is to grow the stash 7% , 3% goes to inflation and 4% goes to SWR. How does that affect my calculation wrt SWR.

[Roger D]

In my opinion there is no merit in common wisdom like "grow the stash 7%", where 7% is not inflation-adjusted. The only figure worth taking into account is the inflation-adjusted growth rate.

There is a Credit Suisse report which tabulates the inflation-adjusted growth rate for a wide range of countries:
http://www.west-info.eu/investing-in-vice-pays-at-least-on-the-stock-exchange/https___publications-credit-suisse/
Unfortunately it does not include Malaysia. Here are figures for a few countries. The first figure is for Equities from 1900 through 2014, expressed as percent growth per year above inflation. The second figure is for Bonds from 1900 through 2014, again expressed as percent growth per year above inflation:

Australia 7.3%, 1.7%
Canada 5.8%, 2.2%
Denmark 5.3%, 3.3%
Finland 5.3%, 0.2%
France 3.2%, 0.2%
Ireland 4.2%, 1.6%
New Zealand 6.1%, 2.1%
Portugal 3.4%, 0.6%
South Africa 7.4%, 1.9%
Spain 3.7%, 1.8%
Sweden 5.8%, 2.8%
Switzerland 4.5%, 2.3%
United Kingdom 5.3%, 1.6%
United States 6.5%, 2.0%

These figures are calculated meaningfully for mustachian purposes. They are total return figures (dividends plus capital growth), they are real returns (inflation-adjusted), and they are annual figures calculated using geometric means not arithmetic means.

[neonlight]

In my opinion there is no merit in common wisdom like "grow the stash 7%", where 7% is not inflation-adjusted. The only figure worth taking into account is the inflation-adjusted growth rate.

There is a Credit Suisse report which tabulates the inflation-adjusted growth rate for a wide range of countries:
http://www.west-info.eu/investing-in-vice-pays-at-least-on-the-stock-exchange/https___publications-credit-suisse/
Unfortunately it does not include Malaysia. Here are figures for a few countries. The first figure is for Equities from 1900 through 2014, expressed as percent growth per year above inflation. The second figure is for Bonds from 1900 through 2014, again expressed as percent growth per year above inflation:

Australia 7.3%, 1.7%
Canada 5.8%, 2.2%
Denmark 5.3%, 3.3%
Finland 5.3%, 0.2%
France 3.2%, 0.2%
Ireland 4.2%, 1.6%
New Zealand 6.1%, 2.1%
Portugal 3.4%, 0.6%
South Africa 7.4%, 1.9%
Spain 3.7%, 1.8%
Sweden 5.8%, 2.8%
Switzerland 4.5%, 2.3%
United Kingdom 5.3%, 1.6%
United States 6.5%, 2.0%

These figures are calculated meaningfully for mustachian purposes. They are total return figures (dividends plus capital growth), they are real returns (inflation-adjusted), and they are annual figures calculated using geometric means not arithmetic means.

Thanks Roger, just to be clear they are inflation adjusted, before inflation the figures would be 6.5% + 1.7% = 8.2%, assuming it's 1.7% inflation rate.

[Roger D]

...just to be clear they are inflation adjusted, before inflation the figures would be 6.5% + 1.7% = 8.2%, assuming it's 1.7% inflation rate.

Yes that's correct.

[Acastus]

The rest of the question is, "what is a reasonable expected return for my country?" What are the long term stock and bond returns where you live? What can you expect from a stock/bond ratio that let's you sleep at night? Subtract the inflation from the return to get a SWR.

You might also ask if you are diversified enough by holding domestic funds, or what we in the US consider emerging markets? I think I would try to hold more in global funds, rather than Maylasian equities. Expats or Pacific Rim mustachians, please chime in.

[Eric]

Malaysia has an average inflation of 3.5%, that's about double US's rate.

The common wisdom here is to grow the stash 7% , 3% goes to inflation and 4% goes to SWR. How does that affect my calculation wrt SWR.

I hope that's not common wisdom, because it's wrong.  The 4% SWR has nothing to do with a 7% return nor 3% inflation.  It was derived through backtesting past scenarios that included periods that had double digit inflation and/or low single digit or even negative returns.  The long term stock market average return in the US is 7% after inflation, so if you're subtracting inflation from that, you're double counting it.  It is definitely not a simple subtraction calculation from long term averages. 

That said, your question is an interesting one, and one that will affect me personally as well, as I plan to retire outside of the US.  Obviously you wouldn't want to invest 100% of your portfolio in companies based only in a small country/economy, even if you live there.  The risks of a lack of diversification would be way larger than the risks of somewhat higher inflation, so I think we can all agree that international diversification is best.

Part of the solution is that when you invest in other parts of the world, your returns correspond to the currency in which you're invested.  So if you buy US stocks, you receive a return in US Dollars (USD).  Inflation in Malaysia would affect the Ringgit, but it would not affect the USD.  So when your returns are calculated, or when you sell to fund your retirement, your USD returns end up buying more Ringgit because they were not inflated (as much).  Similar to investments from the Euro Zone, Great Britain, China, etc. if they also experienced lower inflation.

I've personally noticed this when investing in international stock funds over the last few years.  The returns seem low, but that's partially because the USD is has been strong so when the international returns are converted back to USD, they are smaller due to the exchange rate.  However, if the USD were to experience higher inflation, the opposite would occur.  Similar with if the USD loses value to the Euro, Yen, Yuan, etc., which it will eventually because currency exchange rates are somewhat cyclical.

So basically, most of your returns should still outpace inflation, because with a global porfolio, your returns will reflect the currency they're invested in.  Of course, this will vary somewhat based on your actual holdings and asset allocation.  It would not be a terrible idea to plan for a slightly lower withdrawal rate to help offset some of these concerns.

[neonlight]

Malaysia has an average inflation of 3.5%, that's about double US's rate.

The common wisdom here is to grow the stash 7% , 3% goes to inflation and 4% goes to SWR. How does that affect my calculation wrt SWR.

I hope that's not common wisdom, because it's wrong.  The 4% SWR has nothing to do with a 7% return nor 3% inflation.  It was derived through backtesting past scenarios that included periods that had double digit inflation and/or low single digit or even negative returns.  The long term stock market average return in the US is 7% after inflation, so if you're subtracting inflation from that, you're double counting it.  It is definitely not a simple subtraction calculation from long term averages. 

That said, your question is an interesting one, and one that will affect me personally as well, as I plan to retire outside of the US.  Obviously you wouldn't want to invest 100% of your portfolio in companies based only in a small country/economy, even if you live there.  The risks of a lack of diversification would be way larger than the risks of somewhat higher inflation, so I think we can all agree that international diversification is best.

Part of the solution is that when you invest in other parts of the world, your returns correspond to the currency in which you're invested.  So if you buy US stocks, you receive a return in US Dollars (USD).  Inflation in Malaysia would affect the Ringgit, but it would not affect the USD.  So when your returns are calculated, or when you sell to fund your retirement, your USD returns end up buying more Ringgit because they were not inflated (as much).  Similar to investments from the Euro Zone, Great Britain, China, etc. if they also experienced lower inflation.

I've personally noticed this when investing in international stock funds over the last few years.  The returns seem low, but that's partially because the USD is has been strong so when the international returns are converted back to USD, they are smaller due to the exchange rate.  However, if the USD were to experience higher inflation, the opposite would occur.  Similar with if the USD loses value to the Euro, Yen, Yuan, etc., which it will eventually because currency exchange rates are somewhat cyclical.

So basically, most of your returns should still outpace inflation, because with a global porfolio, your returns will reflect the currency they're invested in.  Of course, this will vary somewhat based on your actual holdings and asset allocation.  It would not be a terrible idea to plan for a slightly lower withdrawal rate to help offset some of these concerns.

Thanks Eric. You are right, I seem to be double counting when U.S. market returns of >= 7% has already factored in inflation. What I might need to do is to look at market return average in Malaysia and also interest rates. So say hypothetically Malaysia's market return is 6%, and inflation is 4%, that means my SWR could be 2%. I might be oversimplifying but this is a general guide.

How did your international stock fund end up giving a lower return? If you are indexing globally you should be getting a fine return, many of the mutual funds managed in APAC outperformed Vanguard, so much so that index investing proponents in the region is putting money in regional/national multi stocks mutual funds in my part of the world. Do you know the breakdown of your funds?

And you are spot on, despite potentially  pulling a higher return in fact, international stocks after USD conversion might loss out to USD's strong rally. For example Ringgit was badly punished with a 4.5% decline against USD, so if you bought U.S. stocks in 2016 and you retired in Malaysia you would have made a killing! :)))

You make a great point about diversification. It's something I take big measures to achieve for someone with a very modest stack. I am buying/holding
- RMB bond inside China for 5.5% return
- high risk P2P lending in South East Asia for 12% return
- blue chips stocks in Malaysia, HK, US
- Malaysian government bond for 6% return
- cryptocurrency which knows no border
- highly illiquid estates in Malaysia for ~6% return
- US ETF soon maybe?
- US Precious metal soon maybe?

Out of curiosity, where do you plan to retire?

[Eric]

How did your international stock fund end up giving a lower return?

What I mean is that compared to the return that I would've received if the currency exchange rate was static, the return was lower due to currency conversion.  I'll use the Euro, just for comparison purposes.  A portion of my international fund buys European stock/funds and the return on that portion is denominated in Euros.  When converted back into USD, the return is lower because recently the USD appreciated against the Euro.  So each Euro that I earned was worth less in USD because of currency fluctuation (also called currency risk).  This can also work the opposite way, where returns are larger due to a falling USD.

When we look at country specific inflation, what that does is cause their currency to be worth less compared to other more stable currencies.  Since my investments will have returns driven by (mostly) other currencies, it helps offset that inflation because upon conversion, they buy more.  It's not perfect, but it's a pretty good hedge.

And you are spot on, despite potentially  pulling a higher return in fact, international stocks after USD conversion might loss out to USD's strong rally. For example Ringgit was badly punished with a 4.5% decline against USD, so if you bought U.S. stocks in 2016 and you retired in Malaysia you would have made a killing! :)))

You make a great point about diversification. It's something I take big measures to achieve for someone with a very modest stack. I am buying/holding
- RMB bond inside China for 5.5% return
- high risk P2P lending in South East Asia for 12% return
- blue chips stocks in Malaysia, HK, US
- Malaysian government bond for 6% return
- cryptocurrency which knows no border
- highly illiquid estates in Malaysia for ~6% return
- US ETF soon maybe?
- US Precious metal soon maybe?

And I think that will serve you well.  Here's the thing about the 4% rule.  It is basically a test using US stocks only.  So it's not an exact science as to how things will perform using other asset classes.  And of course it doesn't predict the future.  At the same time, we know from various studies that diversification across asset classes and locations is generally a good thing for investors.  We know that it can lower volatility without sacrificing return.  So while we don't have the same backtesting and long term data sets that the Trinity Study (among others) used to come up with the 4% rule, we can still infer that using good investing practices like diversification, along with the hopefully continued lower volatility, should prove to make 4% a safe WR for all internationally diversified portfolios as well.  Of course only time will tell, but I see no reason why diversification in this case would prove to have worse results.  And of course it should also help battle inflation.

Out of curiosity, where do you plan to retire?

Oh, I have no idea!  I plan to retire shortly with a goal to slow travel throughout the world for a number of years.  The list of places that I want to live/visit is extensive.  Kuala Lumpur, Penang and Malacca are on that list.  If you have other recommendations, or reasons against those three, I'm certainly open to hear them.  In the end, I may choose to settle down someplace away from the US, or I may choose to return, but at this point, I'm looking forward to taking my time to make a difficult decision.

[Playing with Fire UK]

Remember that it is possible for a country to have high-ish inflation and an individual to have modest inflation. If inflation is driven by lots of people buying new phones and cars, and you aren't doing that, then your personal inflation will be lower. If inflation is being driven by basic food and energy costs, while disposable fashion gets cheaper, then your personal inflation may be higher.

If you aren't committed a particular country, you can keep the majority of your stache in dollars, and go where the dollar is strong against the local currency. If inflation picks up so that there is a better option, you try that instead.

[neonlight]

Remember that it is possible for a country to have high-ish inflation and an individual to have modest inflation. If inflation is driven by lots of people buying new phones and cars, and you aren't doing that, then your personal inflation will be lower. If inflation is being driven by basic food and energy costs, while disposable fashion gets cheaper, then your personal inflation may be higher.

If you aren't committed a particular country, you can keep the majority of your stache in dollars, and go where the dollar is strong against the local currency. If inflation picks up so that there is a better option, you try that instead.

That's an interesting observation, though I suspect national inflation rate is measured from a basket of mostly on basic/necessity item.

[neonlight]

What I mean is that compared to the return that I would've received if the currency exchange rate was static, the return was lower due to currency conversion.  I'll use the Euro, just for comparison purposes.  A portion of my international fund buys European stock/funds and the return on that portion is denominated in Euros.  When converted back into USD, the return is lower because recently the USD appreciated against the Euro.  So each Euro that I earned was worth less in USD because of currency fluctuation (also called currency risk).  This can also work the opposite way, where returns are larger due to a falling USD.

When we look at country specific inflation, what that does is cause their currency to be worth less compared to other more stable currencies.  Since my investments will have returns driven by (mostly) other currencies, it helps offset that inflation because upon conversion, they buy more.  It's not perfect, but it's a pretty good hedge.

We are on the same page.

Oh, I have no idea!  I plan to retire shortly with a goal to slow travel throughout the world for a number of years.  The list of places that I want to live/visit is extensive.  Kuala Lumpur, Penang and Malacca are on that list.  If you have other recommendations, or reasons against those three, I'm certainly open to hear them.  In the end, I may choose to settle down someplace away from the US, or I may choose to return, but at this point, I'm looking forward to taking my time to make a difficult decision.

All are great places. :) And a good way to travel all around South East Asia using Malaysia as the base aka AirAsia's home base.

[Playing with Fire UK]

Remember that it is possible for a country to have high-ish inflation and an individual to have modest inflation. If inflation is driven by lots of people buying new phones and cars, and you aren't doing that, then your personal inflation will be lower. If inflation is being driven by basic food and energy costs, while disposable fashion gets cheaper, then your personal inflation may be higher.

If you aren't committed a particular country, you can keep the majority of your stache in dollars, and go where the dollar is strong against the local currency. If inflation picks up so that there is a better option, you try that instead.

That's an interesting observation, though I suspect national inflation rate is measured from a basket of mostly on basic/necessity item.

In my country (see here) the basket includes tobacco products, children's toys, child care and package holidays. None of these apply to me, so my rate is different. Some of the products (a new car, private surgery, nanny fees, new electronic equipment) I wouldn't consider necessities.

This doesn't mean that the inflation rate is meaningless; just that I would need to look into what was driving it before I got concerned about a particular country. I don't know how these items are weighted, or how other countries decide on their baskets.

[Acastus]

You should average inflation rates over a long period to create a more robust prediction of future inflation rates. The average inflation rate over the last 50 years in the USA is 3%, but when I started my career 30 years ago, it was 4%. Over the last 10 years, it was only 2-2.5%. You need to plug a single number into most calculator.

It is better to overestimate inflation and have more spending power than you expected.

[Trudie]

This is a valid question, but I also think people don't think opportunistically enough about their "personal" inflation rates.  Macroeconomic measures are crude tools to make decisions for your household; that is not to say that they aren't directionally helpful, but obviously spending decisions and inflation rates at the household level can vary.

This Fed article, "What's in Your Market Basket?" explains it quite well:
https://research.stlouisfed.org/publications/page1-econ/2015/10/01/whats-in-your-market-basket-why-your-inflation-rate-might-differ-from-the-average/

My guess is that the typical Mustachian has enough flexibility and tools in their toolbox to time household purchases (or refrain from them at all) that reduce the inflation rate for their households.  I don't live on a farm, but occasionally I watch the show "Market to Market" to learn what's going on in the commodities markets and can predict when prices for household staples are going up or down.  I use these as opportunities to stock up on pork (when beef prices are going up), eat more beans instead of meat.... that sort of thing.

Andrew Tobias' "The Only Investment Guide You'll Ever Need" had an excellent chapter on this topic.