Author Topic: Calculating inflation for portfolio withdrawals  (Read 1958 times)

Eric

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Calculating inflation for portfolio withdrawals
« on: March 21, 2017, 06:32:05 PM »
**For the purposes of this discussion, let's assume that CPI is an accurate representation of inflation**

Every inflation calculation/simulation I've ever seen uses CPI data for the US when calculating withdrawals.   And of course the point of this is to maintain your spending power and standard of living when living off your portfollio.  But what bothers me is that this is a completely US centric approach.  I'm looking at simulations showing S&P 500 returns coupled with US CPI.  The best thing I've come up with are a handful of Vanguard white papers (this one, among others), that show that a globally diversified portfolio is supposed to have similar returns with lower volatility.  Which sounds great, but of course the sample sizes are small and the results aren't all the customizable.  Not to mention that we don't really have inflation numbers for this.  What is the impact when investing using a globally diversified portfolio?  How would it impact the yearly inflation adjustment?  Does it matter? 

To further complicate matters, I plan to retire outside of the US, with a focus on cheaper countries.  In most of the developing world, inflation is much greater than in the developed world.  As such, if I choose to follow US CPI inflation adjustments, my standard of living would be continuously eroded by inflation.  If I choose to follow local inflation to maintain my standard of living, I'm at risk of withdrawing too much over the course of my retirement and am greater risk for portfolio depletion.  How would you reconcile that issue?

I'm struggling with how to wrap my brain around the impact of having both international investments and being subject to higher inflation rates. 

Radagast

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Re: Calculating inflation for portfolio withdrawals
« Reply #1 on: March 21, 2017, 10:15:35 PM »
Long overly deep write up on the topic from the bogleheads blog, which apparently says it matters more than I would have thought.
https://finpage.blog/2017/03/18/investing-in-the-world-part-1/

Prairie Stash

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Re: Calculating inflation for portfolio withdrawals
« Reply #2 on: March 22, 2017, 11:29:14 AM »
If you retire abroad you have a third issue; exchange rates. Witness post recession Canada and the returns on the S&P based on USD vs CDN dollars.

In a lot of cases high local inflation makes the US exchange rate worse, if you hold stocks in USD you get more local currency when you sell.

It's not true when local economies are on fire and driving up inflation. The hedge there is to have local stocks, they will beat inflation since they're driving the inflation.

Retire-Canada

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Re: Calculating inflation for portfolio withdrawals
« Reply #3 on: March 22, 2017, 11:42:06 AM »
To further complicate matters, I plan to retire outside of the US, with a focus on cheaper countries.  In most of the developing world, inflation is much greater than in the developed world.  As such, if I choose to follow US CPI inflation adjustments, my standard of living would be continuously eroded by inflation.  If I choose to follow local inflation to maintain my standard of living, I'm at risk of withdrawing too much over the course of my retirement and am greater risk for portfolio depletion.  How would you reconcile that issue?

All low cost foreign destinations are not going to be affected the same way by inflation. So stay flexible and if you find yourself someplace where local inflation is significantly out pacing the returns of your 'stach it's time to leave and move to a new location. One of the beautiful aspects of FIRE is that you are not tied to a specific location because you need to find work.

The same applies to poor currency exchange rates. Just go somewhere that's more favourable if you need to.
« Last Edit: March 22, 2017, 11:43:52 AM by Retire-Canada »

Eric

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Re: Calculating inflation for portfolio withdrawals
« Reply #4 on: March 22, 2017, 01:35:17 PM »
Long overly deep write up on the topic from the bogleheads blog, which apparently says it matters more than I would have thought.
https://finpage.blog/2017/03/18/investing-in-the-world-part-1/

That's pretty good timing.  Thanks for the link.  It helps answer a little bit, but suffers from the same small sample size issue, not only in years but also in number of countries.  However I am encouraged that it shows USD denominated investments would have fared just fine with a 4% WR. 

I wonder how it changes when adding developing countries.  Both returns and inflation should be higher, but it's hard to know what the overall affect would be.

I'll keep my eye out for part 2.

Eric

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Re: Calculating inflation for portfolio withdrawals
« Reply #5 on: March 22, 2017, 01:50:16 PM »
To further complicate matters, I plan to retire outside of the US, with a focus on cheaper countries.  In most of the developing world, inflation is much greater than in the developed world.  As such, if I choose to follow US CPI inflation adjustments, my standard of living would be continuously eroded by inflation.  If I choose to follow local inflation to maintain my standard of living, I'm at risk of withdrawing too much over the course of my retirement and am greater risk for portfolio depletion.  How would you reconcile that issue?

All low cost foreign destinations are not going to be affected the same way by inflation. So stay flexible and if you find yourself someplace where local inflation is significantly out pacing the returns of your 'stach it's time to leave and move to a new location. One of the beautiful aspects of FIRE is that you are not tied to a specific location because you need to find work.

The same applies to poor currency exchange rates. Just go somewhere that's more favourable if you need to.

I definitely view the flexibility as a key component to my plan.  I'm more worried about long term issues.  Basically, all developing economies are going to have higher average inflation than the US. (or other developed economies)  So while I have the ability to move around based on short term trends, the overall long term trend would seem to cause a consistently declining (real) spending amount no matter where I am.  This is assuming I use CPI to figure out yearly COLA (if needed).

I guess this can be solved like anything else - start with more money.  Or maybe it doesn't matter that much.  Even if the prices are rising faster, it should still be cheaper than the US.

Retire-Canada

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Re: Calculating inflation for portfolio withdrawals
« Reply #6 on: March 22, 2017, 02:08:59 PM »
I guess this can be solved like anything else - start with more money.  Or maybe it doesn't matter that much.  Even if the prices are rising faster, it should still be cheaper than the US.

If you are saving 25x an average US FIRE budget and then moving to a LCOL country you will be below a 3%WR likely and your 'stach should continue to compound/grow unless you get terribly unlucky.

If OTOH you are saving 25x a LCOL country FIRE budget than I understand your concern as you won't be starting out with a very low WR.

Gimesalot

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Re: Calculating inflation for portfolio withdrawals
« Reply #7 on: March 22, 2017, 02:21:18 PM »
I think that you need to take a look at inflation against which currency.  For example, I plan to spend the first few years of FIRE in Argentina.  Currently, inflation is running over 30% against the Argentine peso.  This is in part because the peso is losing value.  When compared to the US Dollar, the inflation is much lower.  I can't find any numbers, but to me it looks like it's somewhere between 5% to 10%. 

So, it's important to take into account the source of the inflation and which currency it's tied to.

Eric

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Re: Calculating inflation for portfolio withdrawals
« Reply #8 on: March 22, 2017, 02:23:47 PM »
I guess this can be solved like anything else - start with more money.  Or maybe it doesn't matter that much.  Even if the prices are rising faster, it should still be cheaper than the US.

If you are saving 25x an average US FIRE budget and then moving to a LCOL country you will be below a 3%WR likely and your 'stach should continue to compound/grow unless you get terribly unlucky.

If OTOH you are saving 25x a LCOL country FIRE budget than I understand your concern as you won't be starting out with a very low WR.

The former, but it's not quite that cheap as I'm not picking one country.  I plan to slow travel, so plane tickets, visas, shorter term apartment rentals, more frequent ground transportation, etc. all cost a bit more than picking one spot and sticking there.  But of course, that's a choice as well and comes with the option to cut back by moving slower.  And it might change once I get out there anyway, based on preference more than cost though.  It's hard to know your travel pace before traveling.

But as you said before, flexibility probably solves all of my issues...

Eric

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Re: Calculating inflation for portfolio withdrawals
« Reply #9 on: March 22, 2017, 02:27:08 PM »
I think that you need to take a look at inflation against which currency.  For example, I plan to spend the first few years of FIRE in Argentina.  Currently, inflation is running over 30% against the Argentine peso.  This is in part because the peso is losing value.  When compared to the US Dollar, the inflation is much lower.  I can't find any numbers, but to me it looks like it's somewhere between 5% to 10%. 

So, it's important to take into account the source of the inflation and which currency it's tied to.

Yeah, that's a good point.  I started making a historical exchange rate guide a while back, as a way to gauge which countries were relatively cheap/expensive compared to past rates.  It sort of petered out though.

I'm still interested in how investing globably affects inflation adjusted withdrawals.  But I guess if I just choose a low inflation adjustment and stay flexible from there, it might not matter much.  But still, numbers and studies are fun!

Radagast

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Re: Calculating inflation for portfolio withdrawals
« Reply #10 on: March 22, 2017, 09:52:42 PM »
When I first looked at that link I posted I thought you might have to worry. Looking closer, it seems like the worst cases were actually uber-developed countries with very low inflation. Japan and Switzerland were terrible places to retire on global stock investments. The less developed or high inflation countries such as Singapore, Hong Kong, Italy, and Spain were middle of the pack with regards to safe withdrawal rates. By traveling predominantly in developing countries with presumably high inflation you will probably be OK is what I am seeing. Worst case if you move every year you will end up very average relative to the world, so I now think it won't matter much.