Author Topic: Compound Interest Calculator - Confused About Inflation  (Read 4566 times)

MacAttack7

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Compound Interest Calculator - Confused About Inflation
« on: August 22, 2014, 08:09:52 PM »
I tried searching for this answer which I'm sure is on here, but I couldn't find it.

I waited too long to start saving for retirement, so now I guess my goal is to:
-Save a chunk of money in my 401K
-Quit my job that I hate
-Get a lower-paying job that I enjoy (or find some other way to make money)
-Never touch my 401K until necessary.......let's say 20 years
-Never contribute any more money to my retirement account (assuming this to keep it simple)

My info:
-43 years old
-$53,000 in 401K
-$38,000 in Taxable Acct (can ignore this to keep it simple)
-Spend $15,000/Year

So the calculator says this:
-Using $100,000 to start (assuming I'll have this when I'm 45 to keep it simple)
-7% Interest Rate
-3% Inflation
-20 Years
-Ending Balance $386,000
-Inflation Adjusted $214,000

So if I spend $15,000/year right now that comes to $375,000 if multiplying by 25.
According to the calculator I could have that much after 20 years, or I could be way below if looking at the "inflation-adjusted" number.
At this point I'm a bit confused.  Help !

clarkm04

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #1 on: August 22, 2014, 08:33:19 PM »
In today's dollars, it would be the higher number, but with 3% inflation you would have the buying power of the lower number also calculated today's dollars.

Basically, 250 K goes longer in the past than today and will run out even sooner/faster in the future.

MacAttack7

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #2 on: August 22, 2014, 09:55:49 PM »
In today's dollars, it would be the higher number, but with 3% inflation you would have the buying power of the lower number also calculated today's dollars.

Basically, 250 K goes longer in the past than today and will run out even sooner/faster in the future.

That makes sense, although I was hoping for something to make me feel better.
So anyway, I'm having trouble figuring out how to get to where I want to go.

I want to stay at my current job until I have enough saved so that it'll be close to $400,000 (inflation-adjusted I guess) by the time I'm 65.
(Maybe just $300,000 & count on some social security money)

If I leave my job I'm sort of screwed, so I just wanted to do something I enjoy that'll pay all of my annual expenses until I'm 65 or so.
(Obviously if I figure out a way to retire earlier that would be a-ok.)

I can save $24,430 in my 401K each year.
I can save $20,000 in my taxable account each year.

When can I quit?

clarkm04

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #3 on: August 23, 2014, 06:39:18 AM »
Basically you want 25X your living expenses (based on the Trinity Study and a few MMM posts) when you chose to retire and your retirement should be in a diverse portfolio that matches or beats inflation.

William Bernstein claims in his new book you only need 12-15X if you are banking on Social Security, since SS should cover 12-13X.

I made up these numbers for ease, but let's say you are spending 15 K year right now (from your OP).  Let's say when you are decide to retire your lifestyle now costs you 25 k because of inflation.  That means you would need 625 K (25 X 25,000) assuming 4% SWR at the point of retirement.

That's the tough thing about inflation that it's constantly happening and it's hard to see it without looking at larger expanses of time.  As long as your portfolio is matching/beating inflation it shouldn't matter as long as you have 25X living expenses at the point you retirement.

That calculator was showing you how much you would have in 20 year, but also what your buying power with that amount would be in current dollars giving 3% inflation for 20 years.  The calculators do that because people are better at grasping what they can get with current prices, not future ones.

That's one reason why many on here list a range for retirement, because you might hit your number sooner or later based on portfolio performance


MacAttack7

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #4 on: August 23, 2014, 10:07:38 AM »
Basically you want 25X your living expenses (based on the Trinity Study and a few MMM posts) when you chose to retire and your retirement should be in a diverse portfolio that matches or beats inflation.

William Bernstein claims in his new book you only need 12-15X if you are banking on Social Security, since SS should cover 12-13X.

I made up these numbers for ease, but let's say you are spending 15 K year right now (from your OP).  Let's say when you are decide to retire your lifestyle now costs you 25 k because of inflation.  That means you would need 625 K (25 X 25,000) assuming 4% SWR at the point of retirement.

That's the tough thing about inflation that it's constantly happening and it's hard to see it without looking at larger expanses of time.  As long as your portfolio is matching/beating inflation it shouldn't matter as long as you have 25X living expenses at the point you retirement.

That calculator was showing you how much you would have in 20 year, but also what your buying power with that amount would be in current dollars giving 3% inflation for 20 years.  The calculators do that because people are better at grasping what they can get with current prices, not future ones.

That's one reason why many on here list a range for retirement, because you might hit your number sooner or later based on portfolio performance
I decided I'm not a fan of inflation. 
I think I'd feel comfortable with 20X my living expenses.
So does it make sense that I could retire in 6 years if I stayed at my current job (assuming $15,000 annual expenses as of today)?

Using the "After Inflation" results:
My 401K would then hopefully be at $223,211.
My Taxable account would be $109,345

Joel

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #5 on: August 23, 2014, 10:32:26 AM »
16,000 x 25 = 400,000. Are you sure you can live on 16,000 forever? I understand your urge to retire but trying to live on 20x your annual expenses and having an extremely low annual expense might not be realistic.

MacAttack7

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #6 on: August 23, 2014, 11:35:32 AM »
16,000 x 25 = 400,000. Are you sure you can live on 16,000 forever? I understand your urge to retire but trying to live on 20x your annual expenses and having an extremely low annual expense might not be realistic.
I'm not sure I could do it forever (I'd probably stay right around that amount though), but I was just trying to figure out the absolute minimum amounts.

I'm also counting on social security.

I'm also not against working at some low-paying job that I enjoy for a while after I escape my current place, so I wouldn't have to touch my savings until I felt more comfortable.
(I'd quit my job now & find something new, but I'd be very highly unlikely to find another job that pays as much; I just don't have a highly desirable skill set.  I applied for a new position last week in my company, so that could help make things a little more tolerable for a few years).  Also I have 4 weeks of vacation to help keep me sane.

YoungInvestor

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #7 on: August 23, 2014, 08:52:29 PM »
I tried searching for this answer which I'm sure is on here, but I couldn't find it.

I waited too long to start saving for retirement, so now I guess my goal is to:
-Save a chunk of money in my 401K
-Quit my job that I hate
-Get a lower-paying job that I enjoy (or find some other way to make money)
-Never touch my 401K until necessary.......let's say 20 years
-Never contribute any more money to my retirement account (assuming this to keep it simple)

My info:
-43 years old
-$53,000 in 401K
-$38,000 in Taxable Acct (can ignore this to keep it simple)
-Spend $15,000/Year

So the calculator says this:
-Using $100,000 to start (assuming I'll have this when I'm 45 to keep it simple)
-7% Interest Rate
-3% Inflation
-20 Years
-Ending Balance $386,000
-Inflation Adjusted $214,000

So if I spend $15,000/year right now that comes to $375,000 if multiplying by 25.
According to the calculator I could have that much after 20 years, or I could be way below if looking at the "inflation-adjusted" number.
At this point I'm a bit confused.  Help !

100 000 * 1.07^20 = 386 968$. That's the dollar amount after 20 years of 7% returns compounded.

386 968 / 1.03 ^20 = 214 255$. That's the value of that in today's dollars, accounting for 3% inflation. Basically, to buy something you can buy now for 214k $ in 2034, you'd need 387k$.

You should be looking at the inflation-adjusted amount if comparing with your spending in today's dollars.

agent_clone

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #8 on: August 24, 2014, 05:05:17 AM »
When I do these calculations I look at it as, ok so the expected returns are 7%, on average inflation is 3%, so the actual return is 4%.  Instead of trying to complicate the numbers of actual vs what it will appear to be, I simply calcualte a 7%-3% inflation, i.e. 4%, and use the 4% figure to work out how much it would be in inflation terms.  Does that help?

YoungInvestor

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Re: Compound Interest Calculator - Confused About Inflation
« Reply #9 on: August 24, 2014, 06:39:04 AM »
When I do these calculations I look at it as, ok so the expected returns are 7%, on average inflation is 3%, so the actual return is 4%.  Instead of trying to complicate the numbers of actual vs what it will appear to be, I simply calcualte a 7%-3% inflation, i.e. 4%, and use the 4% figure to work out how much it would be in inflation terms.  Does that help?


Quick note here:
Over long periods of time, you will introduce some serious bias in your calculations. The "real" rate of return is 1.07/1.03-1 which is 3.88%. Not too much over a year, but over 20 years, you introduce a difference of 5000$.