Author Topic: How to account for inflation, REALLY?  (Read 2076 times)

netskyblue

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How to account for inflation, REALLY?
« on: January 02, 2018, 02:55:05 PM »
Say I want to retire 20 years from now, and I'd like to be able to spend 40k/year in "today's money."  (I currently rent, and that amount is sufficient today for buying pretty much whatever I want, within reason.  I will hopefully own a home in the future and won't be spending $9500/year in rent, so 40k will be an even more generous amount.)

If we're estimating 3% annual inflation, I'd be needing $70,140.24/year in 2038 money for the same lifestyle, right?

But that seems insane!  Can that really be real? 

My rent (biggest expense) has gone up only $25/mo in the past ten years.  My cell phone bill has gone down 50% from five years ago (switched to a different provider).  Honestly, my expenses (other than what I've allowed due to lifestyle creep) haven't changed that much in the past decade.  Can I *really* expect them to be 1.75 times more in 2038?

MDM

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Re: How to account for inflation, REALLY?
« Reply #1 on: January 02, 2018, 03:23:03 PM »
Say I want to retire 20 years from now, and I'd like to be able to spend 40k/year in "today's money."  (I currently rent, and that amount is sufficient today for buying pretty much whatever I want, within reason.  I will hopefully own a home in the future and won't be spending $9500/year in rent, so 40k will be an even more generous amount.)

If we're estimating 3% annual inflation, I'd be needing $70,140.24/year in 2038 money for the same lifestyle, right?

But that seems insane!  Can that really be real?
Yes, if your lifestyle approximates that upon which the inflation number is based, and if that inflation is 3%/yr.   

Quote
My rent (biggest expense) has gone up only $25/mo in the past ten years.  My cell phone bill has gone down 50% from five years ago (switched to a different provider).  Honestly, my expenses (other than what I've allowed due to lifestyle creep) haven't changed that much in the past decade.  Can I *really* expect them to be 1.75 times more in 2038?
In addition to you possibly having a personal inflation rate different from the average, over the past nine years the annual inflation rates have been at or over 3% only for a string of months in 2011.  E.g., if you are 30 now, inflation has been relatively low for most or all of your career.

Papa bear

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Re: How to account for inflation, REALLY?
« Reply #2 on: January 02, 2018, 03:37:49 PM »
Say I want to retire 20 years from now, and I'd like to be able to spend 40k/year in "today's money."  (I currently rent, and that amount is sufficient today for buying pretty much whatever I want, within reason.  I will hopefully own a home in the future and won't be spending $9500/year in rent, so 40k will be an even more generous amount.)

If we're estimating 3% annual inflation, I'd be needing $70,140.24/year in 2038 money for the same lifestyle, right?

But that seems insane!  Can that really be real? 

My rent (biggest expense) has gone up only $25/mo in the past ten years.  My cell phone bill has gone down 50% from five years ago (switched to a different provider).  Honestly, my expenses (other than what I've allowed due to lifestyle creep) haven't changed that much in the past decade.  Can I *really* expect them to be 1.75 times more in 2038?

Yes.  That could be perfectly reasonable.  Run some inflation calculators and back test. Or look up prices of comparable items from 1985 and see what they were.  (Tech items will not be "comparable")




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galliver

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Re: How to account for inflation, REALLY?
« Reply #3 on: January 02, 2018, 03:45:46 PM »
I think this makes more sense when you look at multiple decades...e.g. Watching mad men (set in 1960s NYC) and figuring out what Peggy's $25/week compensation would mean next to Pete's $75, etc. How much a loaf of bread or subway fare or a hamburger or a phone bill would cost then. Looking up worker pay statistics (min wage, median salary) for that time period.

Of course, past performance is no guarantee of future behavior...but the value of money has been falling for under a century, so I'd plan for it...

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Prairie Stash

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Re: How to account for inflation, REALLY?
« Reply #4 on: January 02, 2018, 04:02:30 PM »
When I started driving the price of gasoline was half of what it is now...a common illustration of inflation, heck when I was a kid a penny candy cost just that, now its a nickel. That does not mean the Average Inflation rate is the same as the inflation on gasoline, some things increase at different rates (education has been increasing faster than average for example).

Why estimate 3%, why not higher or lower? Its somewhat arbitrary when you forecast out too far, its like trying to predict annual stock returns for the next 20 years. The best you can do is remember that the market averaged 7% more than inflation, dividends and gains from 1950-2009, and remember that the market will also boost your savings over 20 years to help you achieve the $70k you may need.

For every doom and gloom market prediction its amazing how the very same people cling to the notion that inflation will be a constant while the market under performs. Just like we can't predict market returns with certainty, you can't predict inflation for the next 20 years (ask the groovy guys and gals from the 70's about inflation).



Jrr85

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Re: How to account for inflation, REALLY?
« Reply #5 on: January 02, 2018, 04:17:46 PM »
Say I want to retire 20 years from now, and I'd like to be able to spend 40k/year in "today's money."  (I currently rent, and that amount is sufficient today for buying pretty much whatever I want, within reason.  I will hopefully own a home in the future and won't be spending $9500/year in rent, so 40k will be an even more generous amount.)

If we're estimating 3% annual inflation, I'd be needing $70,140.24/year in 2038 money for the same lifestyle, right?

But that seems insane!  Can that really be real? 

My rent (biggest expense) has gone up only $25/mo in the past ten years.  My cell phone bill has gone down 50% from five years ago (switched to a different provider).  Honestly, my expenses (other than what I've allowed due to lifestyle creep) haven't changed that much in the past decade.  Can I *really* expect them to be 1.75 times more in 2038?

If you are using an inflation adjusted expected return in your retirement calculations, you probably don't need to do anything else to account for inflation right now. 

For example, in my projections, the expected returns I use run from 4.5% to 6% so that I can see where I should stand under relatively pessimistic and relatively optimistic scenarios.  The projected nest egg is then roughly in today's dollars, and I can just apply the 4% rule and compare that result to what I think my expenses will be based on today's price levels.  Whether inflation ends up averaging 2% and Nominal returns 6.5% (or 8% in the optimistic scenario) or inflation ends up averaging 4.5% and nominal returns 9% (or 10.5% in the optimistic scenario) doesn't matter.  What matters is that the real return end up somewhere in the neighborhood of what you use for your projections. 





 

Cranky

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Re: How to account for inflation, REALLY?
« Reply #6 on: January 02, 2018, 04:33:57 PM »
Some things will go up more than others - housing and transportation move upwards more than anything else, and are harder to adjust to. Food is relatively cheap and we spend less, proportionally, on it than we used to.

Government calculates inflation rather weirdly, but prices do trend up. This is probably not all that noticeable if you are just tracking a few recent years, because we have really had very low inflation since 2008z
« Last Edit: January 03, 2018, 01:37:30 PM by Cranky »

Bicycle_B

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Re: How to account for inflation, REALLY?
« Reply #7 on: January 02, 2018, 04:36:40 PM »
Sometimes stable renters get a price break from lazy landlords who don't want the pain of raising rent and losing a good tenant.  Treasure your advantage but don't assume it will last forever.

+1 to what Jrr85 said.  Simplest way to plan for the future is use current dollars to set the spending level you're comfortable with, then the investing timeline in this article:

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/

The inflation will take care of itself because your investments will grow along with your costs.  Just keep investing and you can reach financial independence.

When I was a kid, inflation in my country (US) was running 7% to 10% per year.  Candy bars went up from 20 cents to 33 cents during that time.  Now they're a lot more.  Inflation rates change in different eras, it's hard to predict whether inflation will average 2% or 5% in the next half century.  For what it's worth, the bankers in charge of trying to control it usually set a target of around 2%.  It is likely that some inflation will occur.  So yes, it's real.

maizeman

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Re: How to account for inflation, REALLY?
« Reply #8 on: January 02, 2018, 04:49:34 PM »
If we're estimating 3% annual inflation, I'd be needing $70,140.24/year in 2038 money for the same lifestyle, right?

In the long term prices will certainly rise, the question is how much and how fast.

In the last decade total inflation as measured by the CPI was only 18.25%, which works out to a CAGR of 1.67%/year. If the next two decades are the same you would only be paying $55,700 for the same lifestyle in 2038.

Also remember that the components of the CPI which are growing a lot faster than the overall index are things like healthcare and the cost of higher education. Tuition at my alma mater grew 4.3%/year in the same decade overall inflation was 1.67%. If you're not paying for any higher education, your personal rate of inflation is almost certainly lower than the "average" consumer used to calculate the CPI number. Edit: Similarly, if you have employer provided healthcare, you probably haven't noticed the increase in the cost of health care/health insurance, since only a little of it is directly passed on to employees. The rest is absorbed by your employer, although it still (invisibly) effects you through slower increases in compensation than you would otherwise receive.
« Last Edit: January 02, 2018, 04:53:46 PM by maizeman »

Christof

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Re: How to account for inflation, REALLY?
« Reply #9 on: January 02, 2018, 04:53:37 PM »
The most important thing to realize, IMO, is that there is no general "inflation". It totally depends on what you spend and how flexible you are... and how lucky. You can change a lot of expenses by moving, changing diet, changing hobbies, shifting priorities...

Asalbeag

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Re: How to account for inflation, REALLY?
« Reply #10 on: January 02, 2018, 09:23:44 PM »
Although if you buy a home now you lock in that same mortgage payment for the next 15 to 30 years. Although your land rental (property taxes) will trend up assuming property prices follow inflation and you are regularly reassessed.

Capt j-rod

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Re: How to account for inflation, REALLY?
« Reply #11 on: January 02, 2018, 09:55:36 PM »
The easiest way to fight inflation is to be flexible with your habits. If certain foods go crazy then switch. Take very good care of what you own and buy high quality when ever possible. Fixed rate interest loans will lock in today's costs. Some things are out of our control, utilities, fuel, insurance, phones, and consumables. Be creative and conservative and you will weather the storm. Traditionally when inflation rises so do returns on investments. Interest on a home in the early 80's was over 15% on a home... Bank cd's were the same return. If inflation soars I will buy more property. Others will shy away due to the expense. I will write off the high interest and re finance when the storm clears. I bought a diesel truck in 2008 when fuel soared. I sold it three years later for close to what I paid for it. Volatility=Opportunity