What are your inflation expectations

[kmt1972]

A good part of my post-retirement strategy includes upcoming inflation expectations over the next 40-50 years. I will be very concentrated in fixed income and the main risk is inflation. Also, inflation will push up nominal AGI which will push me into higher brackets. I do plan to invest small amounts into gold and TIPPS to hedge.

Looking at inflation swaps that trade in the financial markets, I pretty much derived

2013 2.10%
2014 2.30%
2015 2.60%
2016 2.70%
2017 2.80%
2018 3.00%
2019+ 3.00%

Any thoughts out there about your inflation expectations and what you are doing about this risk.

[MichaelB]

Quote:

Originally Posted by kmt1972 A good part of my post-retirement strategy includes upcoming inflation expectations over the next 40-50 years. I will be very concentrated in fixed income and the main risk is inflation. Also, inflation will push up nominal AGI which will push me into higher brackets. I do plan to invest small amounts into gold and TIPPS to hedge. Looking at inflation swaps that trade in the financial markets, I pretty much derived 2013 2.10% 2014 2.30% 2015 2.60% 2016 2.70% 2017 2.80% 2018 3.00% 2019+ 3.00% Any thoughts out there about your inflation expectations and what you are doing about this risk.

Tax tables are indexed to CPI so the real, after inflation tax should remain the same.

[calmloki]

I tend to believe very little about the government reported inflation rate ever since I heard about equivalencies. Steak does not equal hamburger IMHO. On the other hand, using or thinking about what I really think inflation is scares the crap outa me (medical expense, college cost, car part/mechanic cost). I use 3.5% looking ahead because that figure in Quicken retirement planner means we only run out of money about 4 years before we croak.

[kmt1972]

Quote:

Originally Posted by MichaelB Tax tables are indexed to CPI so the real, after inflation tax should remain the same.

From where I see it, not really. Lets use this example. Say I have $1 million in assets that has 1% real after inflation return by investing in fixed income. If inflation is zero then my coupon/capital gains should be $10K. If inflation was say, 9%, then my coupon/capital gains would be $100K since my nominal rate of return would be 10%. So my AGI in these two cases are either $10K or $100K. Shifting the income tax brackets by 9% does not compensate me for an AGI of 10x bigger. Of course in reality my portfolio would more likely be a mix of fixed income and equities to have me return 10% nominal in a 9% inflation environment. In that case some of the 10% return will not be realized but will be counted as unrealized capital gains. But eventually I will have to pay taxes on those (mostly fake) gains when I do sell said asset.

[braumeister]

I think about 3.5% is the historical average, so that's what I use, but medical costs have a much higher rate.

[Animorph]

Quote:

Originally Posted by kmt1972 From where I see it, not really. Lets use this example. Say I have $1 million in assets that has 1% real after inflation return by investing in fixed income. If inflation is zero then my coupon/capital gains should be $10K. If inflation was say, 9%, then my coupon/capital gains would be $100K since my nominal rate of return would be 10%. So my AGI in these two cases are either $10K or $100K. Shifting the income tax brackets by 9% does not compensate me for an AGI of 10x bigger. Of course in reality my portfolio would more likely be a mix of fixed income and equities to have me return 10% nominal in a 9% inflation environment. In that case some of the 10% return will not be realized but will be counted as unrealized capital gains. But eventually I will have to pay taxes on those (mostly fake) gains when I do sell said asset.

So inflation goes up 9%, your income goes up 1000% (!), and you're complaining?

Spread your gains better, into multiple years, and it will not look that bad. You're taking all your potential capital gains into one year. Or stay in the 15% tax bracket and get the 0% CG rate. Or not a problem inside an IRA. CG's are always a problem with inflation and taxes. That's one reason the tax rate is a little lower than for regular income.

[sengsational]

Quote:

Originally Posted by kmt1972 From where I see it, not really. Lets use this example. Say I have $1 million in assets...

Excellent point made. Inflation can pick your pocket not only if your investments somehow don't keep up (which is a likely reality for many), but also when you are obliged to pay taxes on "gains" that merely keep you even.

[Original Wally]

My spreadsheets are 3% inflation, earnings 6% (3% real).

[Live And Learn]

I use 3.5% inflation and 5% return for a 50/50 portfolio. I tend to be very pessimistic when running these numbers, knowing that things will end up better than they calculate at.

[TOOLMAN]

Quote:

Originally Posted by kmt1972 A good part of my post-retirement strategy includes upcoming inflation expectations over the next 40-50 years. I will be very concentrated in fixed income and the main risk is inflation. Also, inflation will push up nominal AGI which will push me into higher brackets. I do plan to invest small amounts into gold and TIPPS to hedge. Any thoughts out there about your inflation expectations and what you are doing about this risk.

Short answer; I don't know where inflation is going, and I don't suspect anyone else does either, otherwise they would have all the money. :-)
There have been large variations in inflation; over time, and among countries. http://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG

My Speculation; I expect 3% inflation for now, then more than normal in 5 years. I suspect; global population growth, the rise of the global middle class, financial crime; (counterfeiting, cyber crime - electronic funds fraud), end of national austerity programs, all will increase the pace of inflation.

For inflation protection, it seems to me stocks, commodities, & REIT's would be a good hedge. My base model is 3% inflation, with 6% investment growth. I have a small amount of GLD, and a little more in gold miner stocks, which have been dead money. I have som CD & older I-Bonds. I don't see any no, or low risk investment that beats today's inflation, so the Fed is moving me out on the risk curve, for now.

[Midpack]

I use 1-2% real returns in all my calculations. If pressed I'd use historic average (3.3%?) for inflation, but I'd never plug an inflation number into a calculator without knowing what rate of return was being used. So if a calculator assumed 8% returns, I'd enter 6-7% inflation even though I don't expect that at all. And I'm wary of fixed numbers anyway, I'd rather run historic sequences or Monte Carlo to forecast/simulate. Sorry for the long answer. YMMV

[KM]

I use 4% inflation and 5% return (1% real). Inflation is also my biggest concern....because our pensions are not COLA'd (actually mine is sort of, but not until I turn 75). So the higher inflation goes, the more our investments will have to cover it.

Therefore, we made sure we had enough padding in our budget that we could tighten our belts, if need be. And we have some rental property income that I have never included in our "income" projections. I expect those two hedges to get us through any bad times.

[Marc]

I use 2% for inflation estimate for two reasons. First, I tend to substitute cheaper items for more expensive when possible and second, most of my expenses are discretionary so I can always stay in a Hampton Inn instead of Waldorf or Conrad.

Marc

[heeyy_joe]

I keep 20% of my portfolio in TIPS. I consider it an insurance hedge in case there is a big spike in inflation.

[kmt1972]

I use 3.5% for inflation and 0.5% real return. So I mostly assume nominal return of 4%.

[MooreBonds]

Assuming 3% inflation average over next 10-15 years, probably 3.5%-4% average for years 15-30+.

Assuming real portfolio growth of 1%, but will likely see 1.5%-2%.

[traineeinvestor]

It's not CPI that I worry about but the rate of inflation in our personal expenses. Unfortunately, our household expenses are much more heavily weighted to items that have historically gone up by more than the official inflation data: utilities, education, travel, medical, insurance, taxes and other government charges.

I'm currently assuming 4% for personal inflation - which is a really scary number over a retirement that could last 50+ years (at least for DW).

I'm also assuming that over the longer term, stocks and real estate will provide better real returns than bonds, CDs or deposits (although with considerable gut wrenching volatility along the way).

[TOOLMAN]

Quote:

Originally Posted by TOOLMAN My base model is 3% inflation, with 6% investment growth.

S&P & Inflation data. http://inflationdata.com/

[MichaelB]

Quote:

Originally Posted by kmt1972 From where I see it, not really. Lets use this example.

I think the example is extreme and not realistic, but do agree that over a long period of time inflation is the great risk. A real return of only 1% seems too low to finance a realistic early retirement over such a long period of time, as does an investing strategy that depends primarily on fixed income.

[UserRequested]

I use 4% and because I believe in preserving principal and living only on income, I would ensure that my principal compounds by 4% every year.