### Author Topic: Inflation question from a beginner  (Read 10454 times)

#### pennyroyl

• Posts: 2
##### Inflation question from a beginner
« on: September 15, 2014, 03:06:57 PM »
Hi all,

I just started reading MMM and I'm completely hooked! One thing I can't seem to wrap my head around though is how inflation works into all the calculations. If I'm assuming needing \$40k a year and multiplying it by 25, that's adjusting for inflation, correct? That means that 1mil will be my number to hit?

I've also been using a compound interest calculator (http://www.moneychimp.com/calculator/compound_interest_calculator.htm) to try to get an idea of how long it would take me. In this case, should I assume 7% growth since thats the average or do I have to lower to 4% to match the x25 calculation?

*and yes, I have read the article about shockingly simple math to early retirement...but that's assuming starting at 0 and I already have money saved up

Sorry if this is very obvious or basic. I realize it probably is, but for some reason it's just not clicking for me.

Thanks in advance for the help!!

#### Beric01

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##### Re: Inflation question from a beginner
« Reply #1 on: September 15, 2014, 03:17:48 PM »
Yeah, this can be a little strange to wrap one's head around.

What you need to do is calculate you future value of your expected spending based on inflation. For example, I might spend 20K/year today, but be retiring in 10 years, so I would need to figure out how much you would need to cover that amount in 10 years, and multiply that number times 25 to get your "number".

Some calculators like cFIREsim ignore inflation completely in their calculation (results given are in today's dollars), but remember you'll have to add it on in the end if you're trying to calculate your "number" that you need to save sometime in the future.

7.5% returns minus 2.5% inflation, leaving 5% real returns is a common estimate. That gives you 5% returns versus your 4% withdrawal rate, leaving you a healthy margin.
« Last Edit: September 15, 2014, 03:19:32 PM by Beric01 »

#### nawhite

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##### Re: Inflation question from a beginner
« Reply #2 on: September 15, 2014, 03:24:57 PM »
So there are 2 different cases.

1) The 4% rule (and the 25x annual spending, and then 300x monthly spending rules that you get from the 4% rule) all include inflation. If you're using any of those rules you don't need to worry about inflation because it is already assumed. But that requires believing all of the assumptions of the 4% rule (I'm on the side where the 4% rule is too conservative for someone retiring early but I'm probably in the minority)

2) The question of "how much money will I have in X years?" The easiest way to calculate inflation adjusted values is to just decrease your expected return rate by the expected inflation. So using Indexing, you could use a return rate of 8.7% and get your money in pre inflation dollars or use a return rate of 6.8% (the long term inflation adjusted CAGR of the stock market) and find out how much your money would be worth in today's dollars.

#### Beric01

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##### Re: Inflation question from a beginner
« Reply #3 on: September 15, 2014, 03:29:49 PM »
If you're using any of those rules you don't need to worry about inflation because it is already assumed.

The problem is it's NOT assumed. If you're retiring in 5 years, you need to save 25x what your expenses in 5 years will be accounting for inflation, not your expenses of today.

#### clarkm04

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##### Re: Inflation question from a beginner
« Reply #4 on: September 15, 2014, 03:33:09 PM »
If you were retiring this year with 40 K of expenses, you'd need 1 million to adequately retire based on the 25X formula.

Inflation will increase your expenses since things will cost more, so you need to wait closer to retirement to determine what your final number will be.

#### Eric

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##### Re: Inflation question from a beginner
« Reply #5 on: September 15, 2014, 03:35:08 PM »
If you're using any of those rules you don't need to worry about inflation because it is already assumed.

The problem is it's NOT assumed. If you're retiring in 5 years, you need to save 25x what your expenses in 5 years will be accounting for inflation, not your expenses of today.

That doesn't change the 4% rule though, which is what nawhite was commenting on with the sentence you quoted.  The 4% SWR / Trinity Study was adjusted for inflation.

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #6 on: September 15, 2014, 04:26:33 PM »
If you're using any of those rules you don't need to worry about inflation because it is already assumed.

The problem is it's NOT assumed. If you're retiring in 5 years, you need to save 25x what your expenses in 5 years will be accounting for inflation, not your expenses of today.

That doesn't change the 4% rule though, which is what nawhite was commenting on with the sentence you quoted.  The 4% SWR / Trinity Study was adjusted for inflation.

Today's "25x" spending number in the 4% rule only works if you retire right now.  If retire at some point in the future you will need to adjust your spending level, and thus your "25x" number as well.  If you spend 40k today and won't retire for 10 more years then 1M is not your magic number.

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #7 on: September 15, 2014, 04:30:00 PM »
What you need to do is calculate you future value of your expected spending based on inflation. For example, I might spend 20K/year today, but be retiring in 10 years, so I would need to figure out how much you would need to cover that amount in 10 years, and multiply that number times 25 to get your "number".

this

#### pennyroyl

• Posts: 2
##### Re: Inflation question from a beginner
« Reply #8 on: September 16, 2014, 08:26:51 AM »
Thanks for everyone's reply. It's a little clearer now. I think overall it's probably easiest to save away, let the money do it's thing, and wake up one blissful morning and realize...woohoo, I'm retired! :)

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #9 on: September 16, 2014, 08:30:25 AM »
Just save.  You have plenty of time to recheck the math and figure out how much you will need to spend to have a happy life, but it's still going to require years of saving.

#### Prairie Stash

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##### Re: Inflation question from a beginner
« Reply #10 on: September 16, 2014, 08:53:27 AM »
Thanks for everyone's reply. It's a little clearer now. I think overall it's probably easiest to save away, let the money do it's thing, and wake up one blissful morning and realize...woohoo, I'm retired! :)
This is the correct answer.  Don't worry about future inflation, it's variable and easier to calculate in hindsight.  Life happens and changes, be happy without worries.

I set a goal amount, when I'm within 10% of it I'll recalculate.  At that point I'll be within a year of retirement which will give enough time to make plans, future inflation will be irrelevant.

#### The Mobile Mustachian

• Posts: 65
##### Re: Inflation question from a beginner
« Reply #11 on: September 16, 2014, 10:18:50 AM »
Average inflation is about 3.4%. It might be worth using this figure or something close to it for your calculations.

#### pom

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##### Re: Inflation question from a beginner
« Reply #12 on: September 16, 2014, 10:47:59 AM »
Just save.  You have plenty of time to recheck the math and figure out how much you will need to spend to have a happy life, but it's still going to require years of saving.

Totally agree with this.

#### Bob W

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##### Re: Inflation question from a beginner
« Reply #13 on: September 16, 2014, 11:10:32 AM »
The CPI is often stated as the measure of inflation.  There are about 10 other inflation metrics.   Inflation is actually much greater than the CPI indicates.   Real estate,  stocks, water bills, energy have all inflated vastly over the last 30 years.

You might consider looking into investing in Switzerland.   They have a current CPI of 0 and has been for a long time.   They are not printing money at the US rate and have some of the best run banking and insurance companies around.

It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

Of course I could be completely wrong!

But no more so than anyone else here who thinks they have a crystal ball based on the past.

#### Mexitali

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##### Re: Inflation question from a beginner
« Reply #14 on: September 16, 2014, 01:09:05 PM »
Just save.  You have plenty of time to recheck the math and figure out how much you will need to spend to have a happy life, but it's still going to require years of saving.

I need to slow down and remember this. Thank you.

#### dandarc

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##### Re: Inflation question from a beginner
« Reply #15 on: September 16, 2014, 01:33:15 PM »
The CPI is often stated as the measure of inflation.  There are about 10 other inflation metrics.   Inflation is actually much greater than the CPI indicates.   Real estate,  stocks, water bills, energy have all inflated vastly over the last 30 years.

You might consider looking into investing in Switzerland.   They have a current CPI of 0 and has been for a long time.   They are not printing money at the US rate and have some of the best run banking and insurance companies around.

It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

Of course I could be completely wrong!

But no more so than anyone else here who thinks they have a crystal ball based on the past.
So we should avoid inflation by investing in Switzerland where the Franc is expected to inflate relative to the dollar?

#### Eric

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##### Re: Inflation question from a beginner
« Reply #16 on: September 16, 2014, 02:03:29 PM »
The CPI is often stated as the measure of inflation.  There are about 10 other inflation metrics.   Inflation is actually much greater than the CPI indicates.   Real estate,  stocks, water bills, energy have all inflated vastly over the last 30 years.
I would argue the exact opposite.  Inflation is much less of an issue than the CPI indicates.  Being mustachian, I don't buy many consumer products, let alone buying them brand new, so it's of no concern to me how much a "standard basket of goods" costs.  Since my house is smaller and I'm conscious in my energy usage, changes in utility rates affect me less as well.  My biggest non-housing outlay is food, and I'm pretty sure that's gotten cheaper over the last 10+ years.

You might consider looking into investing in Switzerland.   They have a current CPI of 0 and has been for a long time.   They are not printing money at the US rate and have some of the best run banking and insurance companies around.

It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

This sounds like investing advice that I'd hear on a 3am infomercial about how to get rich using One Secret Formula

Of course I could be completely wrong!

Whew!  Saved by the disclaimer!

#### Beric01

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##### Re: Inflation question from a beginner
« Reply #17 on: September 16, 2014, 02:12:20 PM »
This sounds like investing advice that I'd hear on a 3am infomercial about how to get rich using One Secret Formula

Of course I could be completely wrong!

Whew!  Saved by the disclaimer!

Agreed. Sounds like currency speculation, which is NOT investing and very risky.

#### begood

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##### Re: Inflation question from a beginner
« Reply #18 on: September 16, 2014, 02:40:48 PM »
I'm confused.

I'm 50. I want to retire at 60. Do I need to project out inflation for ten years, multiply that by my expected expenses and multiply by 25?

Or does the 4% SWR ratio include projected inflation?

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #19 on: September 16, 2014, 02:51:16 PM »
I'm confused.

I'm 50. I want to retire at 60. Do I need to project out inflation for ten years, multiply that by my expected expenses and multiply by 25?

Or does the 4% SWR ratio include projected inflation?

The 4% SWR includes inflation if you retire right now.  If you retire in 10 years you must take your current "number" and multiply by the inflation rate.  If inflation is 3% per year then (1.03)^10 = 1.34.  You must save 1.34X your current "number".

So if you spend 10k/annually now, you will be spending approximately 13.4k/yr in 2024 because of inflation.  So you will need 13.4k x 25 = 335k in 2024 dollars in 2024 to retire.

#### dandarc

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##### Re: Inflation question from a beginner
« Reply #20 on: September 16, 2014, 02:52:22 PM »
I'm confused.

I'm 50. I want to retire at 60. Do I need to project out inflation for ten years, multiply that by my expected expenses and multiply by 25?

Or does the 4% SWR ratio include projected inflation?
If you've got 25X current expenses or more in invested assets, you're retired.  If you have less than that, then you're not.  4% SWR already factors in inflation.

#### begood

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##### Re: Inflation question from a beginner
« Reply #21 on: September 16, 2014, 02:56:14 PM »
Okay, frugalnacho and dandarc, y'all seem to be saying two very different things. Or are you saying the same thing but I can't wrap my brain around it?

#### Eric

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##### Re: Inflation question from a beginner
« Reply #22 on: September 16, 2014, 03:00:25 PM »
I'm confused.

I'm 50. I want to retire at 60. Do I need to project out inflation for ten years, multiply that by my expected expenses and multiply by 25?
You can if you like, but it's easier and more practical to just wait until you're close and then figure out what you're spending at that point.  All of the models that you can use to project your total stache 10 years out assume constant inflation and steady investment returns, which as we all know is pretty silly.

If you're spending \$30K/year today and can hold that constant for 10 years, then whatever you calculate today would be the same as you'll need in 10 years.  However, most spending adjusts up over time, just because prices rise, so you'll have to adjust the total amount invested to account for that.  If in 10 years, you're now spending \$35K/year (for the same purchasing power), your total investment amount needs to be \$125,000 larger. (\$5K * 25)

Or does the 4% SWR ratio include projected inflation?
When you're in the process of withdrawing 4% per year from your portfolio, yes, that 4% withdrawal amount is supposed to increase every year with an inflation adjustment.

#### Beric01

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##### Re: Inflation question from a beginner
« Reply #23 on: September 16, 2014, 03:02:28 PM »
Okay, frugalnacho and dandarc, y'all seem to be saying two very different things. Or are you saying the same thing but I can't wrap my brain around it?

dandarc is saying if you want to retire today, it's simple: 25x your current spending.

frugalnacho is saying if you want to retire in 10 years it a little more complicated: you will need to multiply your current spending by the expected yearly inflation rate (using 3% as a common example) to account for the reduced value of a 2024 dollar, and multiply THAT number by 25x. Alternatively, you could just wait until 2024 and count your current spending as of that day, but that wouldn't allow for much planning, would it? :-)

#### dandarc

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##### Re: Inflation question from a beginner
« Reply #24 on: September 16, 2014, 03:04:39 PM »
Okay, frugalnacho and dandarc, y'all seem to be saying two very different things. Or are you saying the same thing but I can't wrap my brain around it?

I'd say we're answering 2 different questions - the 4% rule tells you when you're retired - when Retirement Assets / Annual Spending = 25 you're there - no need to worry about inflation.

If you want to know how much money you'll need on that day, then you have to project inflation out, so that you can multiply by 25 to figure it out.  It is an estimate.  Fun to project, but not really strictly necessary - indeed it is at best an estimate - as your life changes over time your personal spending may go up or down, regardless of the overall inflation in the economy.

Case in point - my wife and I are currently in a budget cutting phase - our personal spending has reduced something like 20% since this time last year.  So for us, inflation has been -20% for the last year, not the 3% or 4% average you use in these types of things.  However, I can say with relative certainty that we could sustain our current spending indefinitely - so I ask, "do we have 25X our current spending" Answer is not yet.  Therefore we are not retired yet.

#### begood

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##### Re: Inflation question from a beginner
« Reply #25 on: September 16, 2014, 03:09:39 PM »
Ahhhh, gotcha. Thanks, Beric01 (and dandarc and Eric!!)

In our case, we could retire now, but we'd feel more comfortable doing it in six to ten years, when some expected large expenses are under our belt instead of hovering overhead. I did the multiply "that number" by 1.34 thing, and we're there, but just barely, and we still hope to pay for higher ed and buy a house for cash out of that stash.

So off to work we go! :)
« Last Edit: September 16, 2014, 03:13:59 PM by begood »

#### dandarc

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##### Re: Inflation question from a beginner
« Reply #26 on: September 16, 2014, 03:22:13 PM »
Ahhhh, gotcha. Thanks, Beric01 (and dandarc and Eric!!)

In our case, we could retire now, but we'd feel more comfortable doing it in six to ten years, when some expected large expenses are under our belt instead of hovering overhead. I did the multiply "that number" by 1.34 thing, and we're there, but just barely, and we still hope to pay for higher ed and buy a house for cash out of that stash.

So off to work we go! :)
So you've already got in 2014 dollars the amount you'll need to retire in 2024?  Would these large expenses be more than 25% of your current portfolio?  Because if not, you could pay those today in full and still be within the 4% safe withdrawal rate.

Congratulations on being financially independent!

#### Bob W

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##### Re: Inflation question from a beginner
« Reply #27 on: September 16, 2014, 03:36:04 PM »
The CPI is often stated as the measure of inflation.  There are about 10 other inflation metrics.   Inflation is actually much greater than the CPI indicates.   Real estate,  stocks, water bills, energy have all inflated vastly over the last 30 years.
I would argue the exact opposite.  Inflation is much less of an issue than the CPI indicates.  Being mustachian, I don't buy many consumer products, let alone buying them brand new, so it's of no concern to me how much a "standard basket of goods" costs.  Since my house is smaller and I'm conscious in my energy usage, changes in utility rates affect me less as well.  My biggest non-housing outlay is food, and I'm pretty sure that's gotten cheaper over the last 10+ years.

You might consider looking into investing in Switzerland.   They have a current CPI of 0 and has been for a long time.   They are not printing money at the US rate and have some of the best run banking and insurance companies around.

It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

This sounds like investing advice that I'd hear on a 3am infomercial about how to get rich using One Secret Formula

Of course I could be completely wrong!

Whew!  Saved by the disclaimer!

Yeah I guess investing in an economy with zero inflation and super banks and insurance companies that are diversified internationally, where the nominal average annual income of citizens is the highest in the world was a bad idea.   I just don't understand how those damn Swiss got so rich, when they are such a crap investment.

Maybe, I should really do my research and invest all my money in a vanguard fund that is absolutely guaranteed to do no better than the US stock market.

#### dandarc

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##### Re: Inflation question from a beginner
« Reply #28 on: September 16, 2014, 03:44:07 PM »
The CPI is often stated as the measure of inflation.  There are about 10 other inflation metrics.   Inflation is actually much greater than the CPI indicates.   Real estate,  stocks, water bills, energy have all inflated vastly over the last 30 years.
I would argue the exact opposite.  Inflation is much less of an issue than the CPI indicates.  Being mustachian, I don't buy many consumer products, let alone buying them brand new, so it's of no concern to me how much a "standard basket of goods" costs.  Since my house is smaller and I'm conscious in my energy usage, changes in utility rates affect me less as well.  My biggest non-housing outlay is food, and I'm pretty sure that's gotten cheaper over the last 10+ years.

You might consider looking into investing in Switzerland.   They have a current CPI of 0 and has been for a long time.   They are not printing money at the US rate and have some of the best run banking and insurance companies around.

It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

This sounds like investing advice that I'd hear on a 3am infomercial about how to get rich using One Secret Formula

Of course I could be completely wrong!

Whew!  Saved by the disclaimer!

Yeah I guess investing in an economy with zero inflation and super banks and insurance companies that are diversified internationally, where the nominal average annual income of citizens is the highest in the world was a bad idea.   I just don't understand how those damn Swiss got so rich, when they are such a crap investment.

Maybe, I should really do my research and invest all my money in a vanguard fund that is absolutely guaranteed to do no better than the US stock market.
Sounds to me like more of a case for moving to Switzerland - you'd be more likely to take advantage of the zero inflation by doing that than by the original stated plan.  Then you could move everything over there, and only have to worry about the exchange rate once.

#### begood

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##### Re: Inflation question from a beginner
« Reply #29 on: September 16, 2014, 03:49:36 PM »
Ahhhh, gotcha. Thanks, Beric01 (and dandarc and Eric!!)

In our case, we could retire now, but we'd feel more comfortable doing it in six to ten years, when some expected large expenses are under our belt instead of hovering overhead. I did the multiply "that number" by 1.34 thing, and we're there, but just barely, and we still hope to pay for higher ed and buy a house for cash out of that stash.

So off to work we go! :)
So you've already got in 2014 dollars the amount you'll need to retire in 2024?  Would these large expenses be more than 25% of your current portfolio?  Because if not, you could pay those today in full and still be within the 4% safe withdrawal rate.

Congratulations on being financially independent!

dandarc, if I consider the anticipated house purchase to be a redistribution of assets rather than a flat-out one-time expense, then our expected large expenses would be less than 25% of our current portfolio. If we consider the anticipated house purchase (we don't want a mortgage) to be an expense, then yeah, it's probably right about at 25%. I tend toward the more conservative end (financially speaking), so our plan is to work at least six and maybe ten more years. That would get our daughter through college.

BUT! It is a wonderful feeling to know that if we needed to or wanted to, we could chuck it all, go buy a house in some small town in NC and be DONE. :)

#### Eric

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##### Re: Inflation question from a beginner
« Reply #30 on: September 16, 2014, 04:17:21 PM »
Yeah I guess investing in an economy with zero inflation and super banks and insurance companies that are diversified internationally, where the nominal average annual income of citizens is the highest in the world was a bad idea.   I just don't understand how those damn Swiss got so rich, when they are such a crap investment.

Why do you think that Switzerland is some magic island immune to inflation, when that's obviously not true?

http://www.inflation.eu/inflation-rates/switzerland/historic-inflation/cpi-inflation-switzerland.aspx

Such strange assertions...

#### pom

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##### Re: Inflation question from a beginner
« Reply #31 on: September 17, 2014, 10:11:49 AM »
It would make sense that as the US keeps printing dollars and the Swiss do not print Francs that the Franc will go up in value over time.   So you would be avoiding inflation while investing in some very nice stocks.  Thus your SWR would gravitate to the 6 - 8% range.  Meaning you could retire in half the time.

Careful, the SWR in Swiss Francs is 3.59% instead of 4,02% for the US.

See page 17 of the research paper below:

http://www3.grips.ac.jp/~pinc/data/10-12.pdf

#### JGB

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##### Re: Inflation question from a beginner
« Reply #32 on: September 17, 2014, 11:18:25 AM »
I've always operated on the assumption that using my current spending level (adjusted for any new expenses, such as non-employer health insurance) was sufficient. No multiplier needed.

Why? Because I assume that my income will keep up with inflation as well, meaning that my savings will rise at the same rate as my expenses for a net change that is negligible.

Am I missing something here?

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #33 on: September 18, 2014, 09:02:35 AM »
Okay, frugalnacho and dandarc, y'all seem to be saying two very different things. Or are you saying the same thing but I can't wrap my brain around it?

We are saying the same thing, but I think there is some confusion when people keep saying "4% SWR already factors in inflation."

The 4% SWR factors in inflation for all future withdraws from the time you retire.  It is only applicable at the time of retirement, and the from then on.  If you retire at any point in the future you will need to apply inflation to figure out your "number" (but once you retire you can forget inflation and just use the 4% SWR as it is built in from that point forward).

If you spend \$1/yr now, you need \$25 to retire now. (according to the 25x and 4%swr rules)

If you retire in 1 year your expenses (and thus your 25X expenses number) will have increased by 3%*.  If you retire in 2 years it will have increased 6.1%   10 years will be 34%.  20 years will be 81%.  and so on.

*assumed inflation of 3% per year

#### Breaker

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##### Re: Inflation question from a beginner
« Reply #34 on: September 18, 2014, 09:37:06 AM »
Quick question.  If your expenses are inflating aren't your savings/investments inflating also?  Doesn't inflation effect all money?

If so, than you really don't need to consider inflation in your calculations, it should be automatic.

#### frugalnacho

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##### Re: Inflation question from a beginner
« Reply #35 on: September 18, 2014, 10:12:51 AM »
Quick question.  If your expenses are inflating aren't your savings/investments inflating also?  Doesn't inflation effect all money?

If so, than you really don't need to consider inflation in your calculations, it should be automatic.

No.  Your savings won't inflate at all, but you will lose purchasing power due to inflation.  It just sits in your bank account earning whatever your small interest rate is all the while losing purchasing power.  Your investments may rise faster than inflation, or they could decrease in addition to losing purchasing power due to inflation.

The 4% SWR has inflation baked in at the time you retire.  It only applies if you are going to retire right now.

If you are going to retire at a different time than right now, and you want to calculate the amount of money you need in future dollars you must apply an inflation correction.   Whatever year you eventually retire in, you are going to retire with an investment account comprised entirely of dollars in that year's value.   If you retire in 2020 you will have exclusively 2020 dollars and 2020 expenses.  If you retire in 2050 you will have exclusively 2050 dollars and 2050 expenses.  2020 dollars/expenses are different from 2050 dollars/expenses which are different from 2014 dollars/expenses.

Your investments will go up and down and grow at an overall rate higher than inflation.  You will have to revisit your projection and recalculate as your retirement gets closer.   You cannot simply multiply your current expenses by 25, and peg that as your magic number you need to hit.  That's the magic number you need right now.  That magic number will keep inflating each year.  Once you hit that crossover point inflation will become irrelevant as the 4% SWR has inflation built in.

Another extreme example:

My expenses are \$1,000/yr, therefore I need \$25,000 to retire according to the 4% SWR (this is 2014).  If I can't hit my \$25,000 number for another 100 years, how applicable do you think that number is going to be in the year 2114?  Will I be able to retire in 2114 when my investment account finally hits \$25,000?  No because in 2114 my yearly expenses will be about \$19,000/yr due to inflation, and I will require a 25x number that is about \$480,000.

#### JGB

• Stubble
• Posts: 108
• Age: 37
• Location: Oklahoma
##### Re: Inflation question from a beginner
« Reply #36 on: September 18, 2014, 11:21:34 AM »
If your money is sitting still doing nothing, this is true. But otherwise, why can't you use an estimated post-inflation earn rate for investment earnings?

Then you can use today's values for spending, income, and target (as long as you are comfortable assuming that your income will keep up with inflation).

In your extreme example, if it is going to take 100 years to get to 25k based on today's earnings and your income rises to match inflation, and your investments earn at the post-inflation rate that you estimate when calculating that it will take 100 years... Then at the end of 100 years you would have \$480k.

Am I missing something in there?

• Posts: 41
##### Re: Inflation question from a beginner
« Reply #37 on: September 18, 2014, 12:09:51 PM »
The trick is to simply reduce your expected pre-inflation return by the expected inflation rate. For all calculations, you will then get the inflation-adjusted return and all your numbers will be in inflation-adjusted "today's money."

Calculation: If your expected yearly return is 8% and your expected yearly inflation is 3%, the inflation-adjusted return is correctly calculated as (1.08/1.03)-1=0.049, so 4,9%. [1]

You can then apply the 4% rule to every and any number without any problem. Also, you'll always intuitively know what your expected saved money is worth, because it's in today's money and therefore comparable with today's living expenses.

Concerning your savings rate, I would simply assume that your income adjusts with inflation and so will your savings rate. That's likely to conservative, but better to err on the safe side.

Having said that: The MMM post about the shockingly simple math behind early retirement has all this rolled into a nice little table with % saved vs. years to retirement. It's probably simplest to just use this as a guideline and doing the complicated stuff when necessary (e.g. when you want to calculate the influence of more complicated arrangements such as expected windfalls or pensions etc.). I've been there and done that (break-even-analysis of different mortgage repayment scenarios as well), and must say, it's simply not worth it. Maximize your savings rate and you're golden. :-)

[1] Many people simply subtract inflation from return, which would result in 5% in this example. I guess that's an acceptable estimate, but when doing further calculations such as compound interest, I would use the correct method.
« Last Edit: September 18, 2014, 12:58:42 PM by Blackadder »

#### frugalnacho

• Magnum Stache
• Posts: 3380
• Age: 36
##### Re: Inflation question from a beginner
« Reply #38 on: September 18, 2014, 12:42:05 PM »
If your money is sitting still doing nothing, this is true. But otherwise, why can't you use an estimated post-inflation earn rate for investment earnings?

Then you can use today's values for spending, income, and target (as long as you are comfortable assuming that your income will keep up with inflation).

How exactly does using an estimated post inflation return rate simplify anything? How do you equate today's "target number" to a future "target number"?  It seems to me like you are still including inflation in that, just making the math more complicated than it needs to be.

Say I spend \$40k/yr so I need \$1M, but I currently only have \$500k.  If I assume 3% inflation, and 7% returns (thus making a 4% real return)...how exactly does that help me?  How do I know when I can retire?

In your extreme example, if it is going to take 100 years to get to 25k based on today's earnings and your income rises to match inflation, and your investments earn at the post-inflation rate that you estimate when calculating that it will take 100 years... Then at the end of 100 years you would have \$480k.

Am I missing something in there?

I didn't "calculate" that it would take 100 years, just for the sake of argument I said that it will take 100 years just to demonstrate how much that "target number" will change over the course of 100 years.  The same argument applies to any number of years though.  Your "target number" will increase with inflation every year.

As far as predicting how long it will take to hit some specific number, you can calculate that based on how much you add, what your expected returns are, and what you expect inflation to be.  But then my question is how do you have any idea that \$480k is your target number in 2114?  How do you arrive at that specific number other than scaling up your expenses relative to inflation over that period?

#### frugalnacho

• Magnum Stache
• Posts: 3380
• Age: 36
##### Re: Inflation question from a beginner
« Reply #39 on: September 18, 2014, 01:29:44 PM »
I've always operated on the assumption that using my current spending level (adjusted for any new expenses, such as non-employer health insurance) was sufficient. No multiplier needed.

Why? Because I assume that my income will keep up with inflation as well, meaning that my savings will rise at the same rate as my expenses for a net change that is negligible.

Am I missing something here?

The forum is loading really slow and I think I missed a few posts.

I understand exactly what you are saying, and it will work fine to calculate an estimate of when you will have enough to retire.  In fact that is how I would come up with my initial target date.  The question of the thread wasn't really about how to calculate the retirement date, but rather if inflation was baked into the 4% SWR (which I hope i've made clear).

I hope it's clear to other people that inflation before your retirement date has to be accounted for some where.  I am afraid someone will look at this thread and the 4% SWR and try to calculate their target number like this (which I believe the OP was doing):

I spend \$x/yr today, so I need \$25x to retire.  Then they set "\$25x" as the goal to save for, even though it is going to take 10+ years, and by the time they achieve their "25x" it won't be enough to actually retire on because they calculated a quantity in 2014 dollars, even though they are going to retire on 2024 dollars.