Author Topic: Spreadsheet questions (do you include inflation?)  (Read 3824 times)

ender

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Spreadsheet questions (do you include inflation?)
« on: February 22, 2015, 02:33:10 PM »
This is ridiculous but in spite of several years of obsessively researching FIRE/planning I have never put together a spreadsheet to calculate out years worth of planning. Probably because I figured -- relatively accurately, I guess -- that if you save a ton and minimize your expenses you end up with a pile of money fast. This is true, I guess.

When putting it together, it occurred to me it will be a lot easier to ignore inflation and use non-inflation adjusted dollars. This lets my 401k/IRA contributions be constant (as the amounts increase with inflation) as well as show everything in 2015 dollars.

The rate of return then has to be inflation adjusted, so I've been using 5%. This should convert everything into 2015 dollars again (maybe real rate of return is 7% or 8%, but after inflation is only 5%). I can look at the comparison for a withdrawal rate in 2015 dollars too which is way more meaningful than 2025 or 2030 dollars.

This seems to make things a million times easier and simpler. Inputs are new yearly savings, starting balance, and annual rate of return. Outputs are total balances and also monthly/yearly spending at a withdrawal rate.


Is this still meaningful? Especially for those of us just starting out, what are good ways to handle inflation in our spreadsheets?

sol

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Re: Spreadsheet questions (do you include inflation?)
« Reply #1 on: February 22, 2015, 02:39:58 PM »
I think you have this exactly backwards.  You don't want everything in 2015 dollars, you want 2015 dollars in 2015 dollars and 2030 dollars in 2030 dollars.  The only way inflation is relevant is in your expenses.

The spreadsheet is more simple if you don't try to adjust everything every year.  Build it exactly as you described, with real balances and real contributions, but also with real returns.  Ignore inflation, keep track of your actual dollars.  Otherwise in ten years time you're going to have a spreadsheet that doesn't match your bank balances because it's measuring everything in ten year old dollars.  That would suck.

The only place you have to account for inflation is in your projected spending.  Ignore it everywhere else and the problem takes care of itself.

ender

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Re: Spreadsheet questions (do you include inflation?)
« Reply #2 on: February 22, 2015, 02:50:44 PM »
The only place you have to account for inflation is in your projected spending.  Ignore it everywhere else and the problem takes care of itself.

That's not really true, IRA/401k contribution limits increase based on inflation. 401k matches and after-tax savings do as well (unless you never get another raise, I guess).

I also can't predict what my 2030 spending will be, because I can't know what inflation/etc will be. But I can predict based off current spending, in 2015 dollars. This makes it a heck of a lot more meaningful to see a 3% withdrawal rate of $3000 in 2030 vs a 3% rate of say $5000.


MDM

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Re: Spreadsheet questions (do you include inflation?)
« Reply #3 on: February 22, 2015, 02:58:26 PM »
Is this still meaningful?
Depends on what you want it to mean.

If you are looking to answer "are my finances ok for me to FIRE?" then it appears you have it correct.

If you want to know "what will my balance sheet show in X years?" then you need to include inflation (I think this is sol's point).

Ynari

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Re: Spreadsheet questions (do you include inflation?)
« Reply #4 on: February 22, 2015, 03:05:50 PM »
My spreadsheet calculates nominal dollars in columns demarcated 2015-2050.

Each column has income, money in tax-advantaged accounts (with limits adjusted to inflation - i.e. 401ks increase by $500/year according to IRA rules), tax paid, and expenses. Income is adjusted for hypothetical raises, and expenses are adjusted for inflation depending on what kind of expense they are (for instance, rent would be adjusted for inflation, but mortgage payments would be listed in actual amount for the duration of the loan.)

Investments are increased by 7%.

The only thing it doesn't account for is potential changes in taxation over time, because I don't know that.

I do like it this way instead of simplistically making ROI 5%, because that assumes inflation acts identically on income, all expenses, and investment accounts.  HOWEVER, I just made a separate spreadsheet using the simplistic 5% but no inflation method, to compare, and it's only off by like 1.5% total investment value.  That really doesn't make a significant difference for the purposes of these spreadsheets. (Especially since if I'm assume investment returns are 7%, I'm going to get a TON more variation in actual results due to investment returns, not due to slightly-off inflation adjusted expenses.)

TLDR: If you want to be pedantic, you should account for inflation in nominal terms. But if you just want functional guidelines? Keep doing what you're doing, your predictions are just as useful for FIRE planning.

NaturallyHappier

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Re: Spreadsheet questions (do you include inflation?)
« Reply #5 on: February 22, 2015, 03:09:00 PM »
I inflate everything but my return on investment.  To calculate tax on future withdraws I even bring the future values back to present, compute the tax and then inflate the tax back to the future.  I just posted my spreadsheet today.

http://forum.mrmoneymustache.com/welcome-to-the-forum/my-fire-spreadsheet/


SnackDog

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Re: Spreadsheet questions (do you include inflation?)
« Reply #6 on: February 22, 2015, 03:40:23 PM »
I just include inflation as a variable so I can play with it and see how the graphs change. Set it at 0 if you want to see everything in 2015 dollars.

 I originally had investment return and property appreciation independent, but now have them set at inflation+3.2 (this is conservative) and inflation+1 (California coast), respectively.  This won't work for a stagflation scenario, but I'm doing a single deterministic run anyhow. (I care about property values as I will sell properties when I get old as a way of getting more than 30 years out of a 4% SWR.)

I also escalate healthcare costs at inflation*1.2, which is ok for most cases but may to conservative for low inflation scenarios.  I had it set higher (inflation*2) but ran out of money in high inflation scenarios (like 8% inflation).

Retire-Canada

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Re: Spreadsheet questions (do you include inflation?)
« Reply #7 on: February 22, 2015, 07:21:32 PM »
I think you have this exactly backwards.  You don't want everything in 2015 dollars, you want 2015 dollars in 2015 dollars and 2030 dollars in 2030 dollars.  The only way inflation is relevant is in your expenses.

I keep everything in the current year's dollar value. That tells you what your buying power is at any given year in the future and you can apply the impact of today's tax rules on your future investments since they'll all be in the same uninflated present value.

If you inflate each year's projections you understand less and less what they mean as they depart from the value of todays' dollar.

At one point I included present value [2015 $] and future value [20XX $] on my spreadsheet, but found the future value was not really useful for anything.

As each year passes I'll update the actual current value of my investments which will include inflation and actual ROI. You always understand the buying power of the current $ so that's the logical value to use for FIRE planning.

-- Vik

sol

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Re: Spreadsheet questions (do you include inflation?)
« Reply #8 on: February 22, 2015, 07:30:48 PM »
I keep everything in the current year's dollar value. That tells you what your buying power is at any given year in the future and you can apply the impact of today's tax rules on your future investments since they'll all be in the same uninflated present value.

The problem with that plan is that it requires you to make an all new spreadsheet every year.  Otherwise, ten years down the road you're dealing with dollar values from ten years ago, which made sense to you then but are very confusing to your future self.

Why not just keep everything in the dollars they're actually worth, now and forever?  Inflation isn't a real thing anywhere except where you spend your money.  If you manage to reduce your expenses, then your personal inflation rate is actually negative.  Why would you apply someone else's spending inflation to your personal situation?

Retire-Canada

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Re: Spreadsheet questions (do you include inflation?)
« Reply #9 on: February 22, 2015, 10:33:45 PM »
I keep everything in the current year's dollar value. That tells you what your buying power is at any given year in the future and you can apply the impact of today's tax rules on your future investments since they'll all be in the same uninflated present value.

The problem with that plan is that it requires you to make an all new spreadsheet every year.  Otherwise, ten years down the road you're dealing with dollar values from ten years ago, which made sense to you then but are very confusing to your future self.

Why not just keep everything in the dollars they're actually worth, now and forever?  Inflation isn't a real thing anywhere except where you spend your money.  If you manage to reduce your expenses, then your personal inflation rate is actually negative.  Why would you apply someone else's spending inflation to your personal situation?

Every year you simply update the spreadsheet with your "actual" financial values. Every year, but the current one is an educated guess based on a number of assumptions. Assuming you've used formulas your spreadsheet will update itself as you enter the current year data. It's no extra work since presumably you'd want to work with the latest data you have when making financial decisions.

The only purpose I can see for a long range spreadsheet is to make investment and spending decisions. If the dollars are not in today's dollars you have to adjust your analysis for inflation one way or the other. Since we don't know what inflation will be in the future keeping it in doesn't really do anything for you, but add another assumption. One that doesn't provide any value and just complicates your analysis.

If I want the buying power of $40K in 2015 I need $60K in 2036 at 2% inflation. So when I look at my 2036 investment estimates I'd have to remember to deflate my numbers by 50% or I'd come up with some incorrectly optimistic results.

- Vik