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Inflation and retirement
Old 10-09-2007, 04:05 PM   #1
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Inflation and retirement

In an article entitled "Will Your Retirement Fund Lose Steam? [http://finance.yahoo.com/focus-retir...-post-spending], the author correctly makes the point that inflation gradually but significantly erodes the purchasing power afforded by a non-indexed income stream. But some of the math seems wrong. Does this make sense to you?

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Let's say you're spending $60,000 this year and inflation runs three percent a year. Well, that means that to maintain the same buying power, you would need $61,800 next year ($60,000 + [1 x the inflation rate], or $60,000 x. 1.03). And the year after that you would need $63,654 ($60,000 x 1.03 x 1.03, or $60,000 x 1.032). And in 20 years, you would need $108,367 ($60,000 x. 1.3020)
It seems plausible that after 20 years, inflation averaging 3% p.a. will require an income of $108,367. But $60,000 x 1.302 = (only) $78,120, right? :confused:
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Old 10-09-2007, 04:08 PM   #2
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1.03^20 = 1.8061
1.8061 x 60,000 = 108,366.67
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Old 10-09-2007, 04:51 PM   #3
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Compound Interest --- the impact is much greater than 3%X20=60% actually more than 80% just as d and the article says. The solution, if there is a problem, is to save more, spend less or die!

All in all it is a very good article; thanks for posting it.
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Old 10-09-2007, 05:31 PM   #4
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1.302 came from the article too, not Milton. The article had the correct bottomline number, but the wrong factor to get to it. d has all the right numbers.
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Old 10-09-2007, 06:07 PM   #5
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What bothers me about inflation is not the steady 3% inflation given in the example. Well, that's bad enough, but those of you who are younger may not remember times past when inflation was awfully high.

Some people think runaway inflation could solve the boomer retirement crisis if social security benefits do not keep up. Government has a big influence on the inflation rate.

It seems logical to me to expect runaway inflation to set in sometime soon, perhaps within the next five years. I hope I am wrong! But, I am over-engineering my retirement to take care of that possibility to some extent, should it come to pass. It's worth thinking about.
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Old 10-09-2007, 06:22 PM   #6
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Yup, there's nothing wrong with inflation per se. It's *unexpected* inflation that hurts.
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Old 10-09-2007, 06:28 PM   #7
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Originally Posted by Want2retire View Post
It seems logical to me to expect runaway inflation to set in sometime soon, perhaps within the next five years. I hope I am wrong! But, I am over-engineering my retirement to take care of that possibility to some extent, should it come to pass. It's worth thinking about.
It's definitely worth thinking about. The tradeoff is generally low-yielding TIPs during low inflation times, in exchange for protecting your real earning power if inflation heats up.

I figure I'll store up about 2 years worth of expenses in TIPs, allowing me to get through that long a period of inflation pretty much intact. My understanding is that stocks hate inflation initially but eventually outpace it historically. I guess I'm hedging a bit, but it would at least cushion the fall in an overheated situation.

Anyway, it's worth planning for - I agree.
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Old 10-09-2007, 06:50 PM   #8
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I figure the government is going to solve SS by printing money. Therefore increasing inflations. At the same time they will play with the index, remember the replacement theory i.e. you will replace an expensive protein like beef with chicken so the inflated price of beef should not count. SS payments will not keep up with true inflation, Old folks will starve because they can't afford cat food, fewer to have to pay SS to. Problem solved!
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Old 10-09-2007, 07:47 PM   #9
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Originally Posted by Want2retire View Post
What bothers me about inflation is not the steady 3% inflation given in the example. Well, that's bad enough, but those of you who are younger may not remember times past when inflation was awfully high.
In "Triumph of the Optimists", Dimson & Marsh point out that the 20th century's mean inflation rate is 3%. However the 1970-2000 mean inflation rate is 5%. So it makes a difference which future we "choose" to retire in, or else we have to pile up more in the ER portfolio to handle a wider range of the possible bad scenarios.

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Some people think runaway inflation could solve the boomer retirement crisis if social security benefits do not keep up. Government has a big influence on the inflation rate.
Oh, it'd solve it all right. For the benefit of the government or the Boomers?
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Old 10-09-2007, 07:49 PM   #10
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Quote:
Originally Posted by Want2retire View Post
What bothers me about inflation is not the steady 3% inflation given in the example. Well, that's bad enough, but those of you who are younger may not remember times past when inflation was awfully high.

Some people think runaway inflation could solve the boomer retirement crisis if social security benefits do not keep up. Government has a big influence on the inflation rate.

It seems logical to me to expect runaway inflation to set in sometime soon, perhaps within the next five years. I hope I am wrong! But, I am over-engineering my retirement to take care of that possibility to some extent, should it come to pass. It's worth thinking about.
Its pretty easy to hedge against runaway inflation. Own your own home and buy some commodity funds and/or equities of commodity producers.
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Old 10-09-2007, 08:09 PM   #11
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Its pretty easy to hedge against runaway inflation. Own your own home and buy some commodity funds and/or equities of commodity producers.
Would you choose commodities over either REITs or TIPs in that scenario? All the above?
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Old 10-09-2007, 09:01 PM   #12
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Quote:
Originally Posted by Want2retire View Post
Some people think runaway inflation could solve the boomer retirement crisis if social security benefits do not keep up. Government has a big influence on the inflation rate.

It seems logical to me to expect runaway inflation to set in sometime soon, perhaps within the next five years. I hope I am wrong! But, I am over-engineering my retirement to take care of that possibility to some extent, should it come to pass. It's worth thinking about.
I agree that inflation is something that should get the retiree's attention. That's why I have a 25% TIPS position and about a 4% Ibonds position.

I don't think inflation would come about by government trying to inflate out of their SS commitments though. There are just too many retiree's who would represent a large committed anti-inflation voting block to allow that to happen. But inflation could still kick up for awhile, perhaps due to nasty geopolitical events.

In any event, the market expects inflation of around 2.3% over the next 10 years (10 yr treasury - 10 yr TIPS). This assumes the insurance premium is zero. If the premium is 0.25% then the market is currently forcasting 2.0% inflation. Seems a little low to me given that over the last 10yrs we have had about 2.7% inflation -- and there is still a war going on!

Les
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Old 10-09-2007, 09:52 PM   #13
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...In any event, the market expects inflation of around 2.3% over the next 10 years (10 yr treasury - 10 yr TIPS). This assumes the insurance premium is zero. If the premium is 0.25% then the market is currently forcasting 2.0% inflation. Seems a little low to me given that over the last 10yrs we have had about 2.7% inflation -- and there is still a war going on!
Psssst....it's all about your personal inflation rate.
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Old 10-10-2007, 12:00 AM   #14
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Inflation isn't steady some things go up while others go down or sideways.
I started working in 1966 and remember prices, my first rent was a room for 40 a month then a studio apartment for 67 now you might find a room for 400 or studio for 670 or about 10X in 40 years. Hamburger was 29-39 per pound I saw it this week for 1.99 so less than 10X, computers, internet, cell phones, ipods, color TV, plasma and other items weren't for sale at any price. I earned 1.25 per hour so a I earned my rent in about a week. People are still spending a weeks pay on rent.
The thing is we can control what we buy, chicken isn't much more than it was 40 years ago, rice and pasta are cheap too a nickel candy bar is 3/1. A 12 inch black and white TV was $50.
Food is the easiest to control how much you spend going from one form of food to another adjusting for prices shopping sales, and you can grow some food so it will never be really high.
Lock in the cost of living whenever you can and don't lock in your income. Owning a home even with a 30 year fixed rate mortgage will leave you better off than a renter over time when rents go up faster than property taxes. Most elderly I have know owned homes without mortgages so eliminated that inflation.
You can also choose to buy things that are bargains more than things that aren't. Even if furniture prices went up 500% you aren't buying as much new furniture as a kid leaving home and buying a first home, you can recover the old furniture or remember you liked it. I drive less when gas prices are up and water my lawn less when water prices are up so I have some control.
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