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Factoring in inflation
Old 03-10-2013, 03:23 AM   #1
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Factoring in inflation

Hey everyone,

I've enjoyed browsing these forums since discovering this website a few weeks ago.

I know this is probably a ridiculous question... but I spend a lot of time thinking about inflation and how that affects the number that I have in mind for retirement. I'm 22 and think it would be great to retire sometime in my 50's if I so wish (though hopefully I'll enjoy my job enough not to). I realize that it's probably a wasted effort for someone my age to have a number in mind... but I think it's helpful to have some type of tangible goal.

In today's dollars, I feel that $1.5M would provide a great retirement for the life I would like to live. However, $1.5M today is the equivalent of $6M forty years from now, assuming 3% annual inflation. I find that totally overwhelming though potentially achievable depending on what I pursue professionally.

How do you all factor in inflation in your planning, if at all? Does it affect your goal?

Lifestyle wise I know that I don't want children or a big house, but otherwise would like to live in a nice building, eat well, travel, etc. So maybe my number in today's dollars is too big to begin with? Any thoughts?
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Old 03-10-2013, 07:25 AM   #2
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There have been many posts on this topic. I know I posted a few times explaining my way to factor in inflation. Please feel free to use the Google function at the top of this screen. Welcome to the forum !
Quote:
Originally Posted by ciel View Post
How do you all factor in inflation in your planning, if at all? Does it affect your goal?

Lifestyle wise I know that I don't want children or a big house, but otherwise would like to live in a nice building, eat well, travel, etc. So maybe my number in today's dollars is too big to begin with? Any thoughts?
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Old 03-10-2013, 07:26 AM   #3
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Stop worrying and start saving. Try to put a lot of your earnings aside, aim for 20% or more. Take advantage of 401Ks, bank as much of your raises as practicable, LBYM. To a certain degree inflation takes care of itself if earnings are robust. If the doomsayers are right and we enter a multi-decade period of slow growth you may have to work longer than you would like. If we shift back to historical averages you may be fine at 50.
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Old 03-10-2013, 07:56 AM   #4
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Originally Posted by donheff View Post
Stop worrying and start saving. Try to put a lot of your earnings aside, aim for 20% or more. Take advantage of 401Ks, bank as much of your raises as practicable, LBYM. To a certain degree inflation takes care of itself if earnings are robust. If the doomsayers are right and we enter a multi-decade period of slow growth you may have to work longer than you would like. If we shift back to historical averages you may be fine at 50.
Yeah that sounds like a good strategy rather than trying to somehow factor it in. Thanks for the post.

My goal in the short-term is to save 1/3 of my post-tax income... longer term I'd ideally like to save half or more while living well below my means.
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Old 03-10-2013, 11:31 AM   #5
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Not to downplay inflation, but think of it this way: If you can do this over the long haul, you will be so far ahead of everybody else your age that even if there is great inflation, it will affect them much worse than it does you. Good luck!

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My goal in the short-term is to save 1/3 of my post-tax income... longer term I'd ideally like to save half or more while living well below my means.
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Old 03-10-2013, 11:57 AM   #6
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Quote:
Originally Posted by ciel View Post
but I spend a lot of time thinking about inflation and how that affects the number that I have in mind for retirement. $1.5M today is the equivalent of $6M forty years from now, assuming 3% annual inflation.

Lifestyle wise I know that I don't want children or a big house, but otherwise would like to live in a nice building, eat well, travel, etc. So maybe my number in today's dollars is too big to begin with? Any thoughts?
Welcome Ciel - how great for your to have found this group in your 20s (instead of your 50s like me!) The fact that you're even thinking about inflation does put you light years ahead of most w*rking people, so that's really good.

I look at inflation as just another "variable constant" - always there yet always changing, so yes - you should keep it in your planning process.

Keep your mind open to lifestyle changes because they happen. We've been through many. I've had 2 careers, more j*b positions than I can count, started lots of hobbies (stuck with some and not others). Life is a journey - you'll be surprised 30 years from now when you look back at where you thought you'd be and where you are! How's the song go? "What a long, strange trip it's been!" Hope your journey is as fulfilling as mine is.
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Old 03-10-2013, 12:33 PM   #7
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Congrats on thinking about your long term future. A lot can certainly happen in forty years, much maybe out of your control. I would get your master investing plan together, and stay the course. Consider using index funds, that have very low expense costs so your portfolio is not being chewed up along the way. IMHO, I wouldn't be overly concerned with the 6 million number at this point in your life, just focus on monthly savings and investing. There are many variables that will effect your personal inflation down the road unrelated to the national number such as low cost paid for housing as you mentioned. Many posters have mentioned their personal inflation/expense rate has been flat for many years.
Plus inflation can work for you on the other end too, as your salary may escalate with it too, help mitigating the problem. My first year salary in my career was under $20,000 and I ended up in low 6 figures. Establishing a good solid career, keeping housing costs under control, and don't waste a bunch of money on cars in your early years will help get you down the right path. Cars were my biggest regret looking back. I wasted some serious money on those things back in the day.
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Old 03-10-2013, 12:46 PM   #8
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However, $1.5M today is the equivalent of $6M forty years from now, assuming 3% annual inflation. I find that totally overwhelming though potentially achievable depending on what I pursue professionally.
I began thinking of FIRE at your age too, and had similar concerns. What I failed to fully appreciate at that time was that my savings would generally grow at a pace in excess of inflation. So, yes, 3% over 4 decades will 4x your FIRE number, but earning 5% (i.e. staying 2% ahead of that inflation) will roughly 8x your investments over the same period. The message: save early and let the magic of compounding work for you.
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Old 03-10-2013, 01:17 PM   #9
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Congratulations, thinking about these issues and asking the right questions at age 22 likely puts you into the small percentage of future financial success stories, provided that you follow up. I would suggest not getting bogged down in the planning details and immediately begin saving as much as you can into reputable equity index funds (Vanguard and Fidelity earn high marks here) and you can make refinements later. Get into a 401k/IRA for all you can and save the rest in taxable accounts. The key is: start NOW.

I started working at 24, and fortunately my job sucked during my early years so I began looking for a way out. I found it in the extreme early retirement story of the Ter Horsts. That became my plan. I had no background in personal finance, but I knew it was important not to wait until I had all the answers before setting money aside (good thing because even to this day I learn new stuff all the time). The reason is that compounding means even a mediocre investment plan outruns a very good one if it has many years' head start.

OK I'll get off my urgency soapbox. On your inflation question I usually simply subtract what we expect from projected nominal investments returns. Neither element is for sure going forward, but based on 30-year history one may see numbers like 11%/year nominal minus 3%/year inflation to give 8%/year real returns. In my mind inflation like death and taxes shouldn't be a limiting factor in deciding whether to prepare for the future.

I agree it helps to have an idea of your target liquid net worth, so how did you arrive at your $1.5M estimate? I look at it compared to a rule of thumb safe withdrawal rate of 3% to produce a $45K/year passive income in 2013 USD. Is this consistent with the living standard you envision? If so, then you can reach this level with either--
(a) a lumpsum of 150K today that is left to grow for 30yrs at 8%/yr real or
(b) stashing the equivalent of $12500 per year (in 2013 USD) for the next 30 years in something that returns 8%/yr real
I believe (b) is reachable even with a moderate income provided one can live small for the duration.
http://articles.latimes.com/2011/apr/01/business/la-fi-money-makeover-20110323

Finally while early retirement may be the goal that motivates people to pursue financial independence, I believe that FI is a worthy goal in and of itself. It gives you freedom to choose, so if you like your job, you don't have to give it up, but if anything good or bad happens, you gain more options. My sucky early career became much better over the years as I relied on the paycheck less and less. I have relatives who have taken on enormous mortgages and their families have grown accustomed to lavish lifestyles. From their stories I think their bosses know about and are taking advantage of their situation. They are stuck in well-paying but pretty stressful jobs with no way out for years to come because they need their paychecks to cover debt and have little passive income. By contrast my management knows I can quit whenever I want, so they treat me very well, basically asking my permission before giving me any assignments. I don't coast, I do certain tasks easily and quite well, so I always grab that slice. The ugly pieces go to those who can't refuse. It's ironic how preparing for early retirement removed the need for it in my case.
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Old 03-10-2013, 06:09 PM   #10
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Stop worrying and start saving.
+1. I know $6mil can sound overwhelming, but the sooner you start saving, the sooner you can reach your goal, whether it will be. You are very smart to factor inflation into your calculations. Since you are so young, remember the Rolling Stones song "Time Is On My Side"
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Old 03-10-2013, 07:15 PM   #11
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One factor is that in stock or mutual funds, you own a portion of that company's assets. These hard assets will decouple from an inflated currency. If you have shares in Mrs Grady's cows and they produce enough to give you a pound of cheese a day, if inflation makes that cheese cost 10 times as much, you sell the cheese for.... Then later, the stock for...

Simplistic, but generally this model holds.

I look at my return above inflation and base from that. The Dow is at a record high, unless you count inflation.
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Old 03-11-2013, 07:34 PM   #12
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Thank you for your very informative and helpful replies, everyone.

Quote:
Originally Posted by dunkelblau View Post

I agree it helps to have an idea of your target liquid net worth, so how did you arrive at your $1.5M estimate? I look at it compared to a rule of thumb safe withdrawal rate of 3% to produce a $45K/year passive income in 2013 USD. Is this consistent with the living standard you envision? If so, then you can reach this level with either--
(a) a lumpsum of 150K today that is left to grow for 30yrs at 8%/yr real or
(b) stashing the equivalent of $12500 per year (in 2013 USD) for the next 30 years in something that returns 8%/yr real
I believe (b) is reachable even with a moderate income provided one can live small for the duration.
Money makeover: A millionaire who constantly worries about retirement - Los Angeles Times
I came up with the 1.5M figure by considering that 36k/yr for living expenses would be comfortable for me with my current lifestyle... and the extra would be great for extra security and for things like traveling.

Also, that's an interesting way to look at it (in option B). That would be very achievable for me, but I've always modeled by returns conservatively at 6% nominal. Maybe that's overly conservative but I guess I'd rather be on the safe side. Thanks for your reply.
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Old 03-11-2013, 09:15 PM   #13
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ciel, nothing crazy to be thinking about it at an early age. That's OK!

Don't worry about the final inflation adjusted number. It won't make sense. In 40 years, people will routinely be making 100k, even for modest jobs. It is hard to grasp how this works.

Look at my parents. A great wage was 8k. A retirement goal was 100k. When I started w*rking, a great wage was 50k. A retirement goal was 1M.

Now fast forward to today. A great wage is 100k, retirement goal is maybe 2M. (I think your 1.5M in today's dollars is a bit short, just my opinion.)

When your kids hit the workforce, they'll be starting at 100k, with good wages routinely being 300k or so -- assuming normal runs of inflation. Congress may just have finally gotten rid of the penny by then too. My great grandparents had half-pennies and called a quarter "two bits" for heaven's sakes. Think about it, they actually considered 12 1/2 cents to mean something. The thought of 50k to them was overwhelming. Just like 6 or 10M is to you. Don't worry about it.
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Old 03-12-2013, 01:07 AM   #14
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I do worry about this. Clearly, the entire model is unsustainable in the long term. Trees do not reach the sky.
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The thought of 50k to them was overwhelming. Just like 6 or 10M is to you. Don't worry about it.
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Old 03-12-2013, 09:01 AM   #15
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I do worry about this. Clearly, the entire model is unsustainable in the long term. Trees do not reach the sky.
ob: what I am saying is don't worry about the inflated number to reach in the future. ciel should try to imagine reaching today's number with today's wage first, and not worry about some inflated number. My point being that we'll assume ciel's wage will inflate, and thus the absolute savings will also increase.

Now, should we worry about inflation? Yes, if it gets hot. Many discussions on this forum about that. Hyper or even significant inflation are a worry.

But the fact is if it stays calm, say 3% or so, there will be a day -- if the country survives -- where dollars will be like pennies. There was a time in this country where people worried about 1/2 cents and even mills. Heck, gasoline is still quoted in mills. That's psychology today, but as late as the 40's there were price wars over tenths of a cent per gallon.
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Old 03-12-2013, 09:10 AM   #16
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Originally Posted by donheff View Post
Stop worrying and start saving. Try to put a lot of your earnings aside, aim for 20% or more. Take advantage of 401Ks, bank as much of your raises as practicable, LBYM. To a certain degree inflation takes care of itself if earnings are robust. If the doomsayers are right and we enter a multi-decade period of slow growth you may have to work longer than you would like. If we shift back to historical averages you may be fine at 50.
+1.

When I first starting thinking seriously about a $ FI goal in my 30's, I set a goal of X for us. We lived LBYM and saved to reach our FI goal as soon as possible. I retired early almost 2 years ago (some 30 years later) with 3.3X just through savings & investing (no inheritance or personal/career windfalls, etc.). You might be surprised how much/fast you can accumulate if you set a goal of reaching FI as soon as reasonably possible, vs having X by Y age.

And if you're aggressively saving & investing at age 22, you're way ahead of the curve. I was 33 yo when I really woke up. You might be amused to know that my savings plan at age 22 was if I had more than $4000 saved, I was entitled to buy myself something (guitar, golf clubs, stereo stuff). But I wouldn't let my savings drop below $2000. And it was all simple interest, no investing yet. How's that for a plan?

Congrats to you!
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Old 03-12-2013, 09:14 AM   #17
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ciel, nothing crazy to be thinking about it at an early age. That's OK!

Don't worry about the final inflation adjusted number. It won't make sense. In 40 years, people will routinely be making 100k, even for modest jobs. It is hard to grasp how this works.

Look at my parents. A great wage was 8k. A retirement goal was 100k. When I started w*rking, a great wage was 50k. A retirement goal was 1M.

Now fast forward to today. A great wage is 100k, retirement goal is maybe 2M. (I think your 1.5M in today's dollars is a bit short, just my opinion.)

When your kids hit the workforce, they'll be starting at 100k, with good wages routinely being 300k or so -- assuming normal runs of inflation. Congress may just have finally gotten rid of the penny by then too. My great grandparents had half-pennies and called a quarter "two bits" for heaven's sakes. Think about it, they actually considered 12 1/2 cents to mean something. The thought of 50k to them was overwhelming. Just like 6 or 10M is to you. Don't worry about it.

+1.... I was going to write something like this...

For you now, inflation in your wages should take care of inflation.... it is only when you stop earning an inflating wage and start living on a portfolio will you need to worry about inflation...
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