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What's all this about 3%?
Old 08-04-2008, 06:51 PM   #1
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What's all this about 3%?

I was listening to a recent InvestTalk radio show (I was listening to the podcast, actually, not live), where he was talking about retirement stuff -- the July 23 show: http://investtalk.hitfastforward.com/. He was saying that, because of inflation, I should be adding another 3% per year when figuring out my expenses/retirement needs. I haven't done that, but I'm about to retire (or was planning to). If factoring in an additional 3% is really the best thing to do, then, I figure that for the entirety of my retirement years, that's a bunch of money. Should I stay at work for another year? The alternative, I know, would be to cut down on my expenses, in my planning which I've already done as much as I'm comfortable with. Thanks for your help.
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Old 08-04-2008, 06:58 PM   #2
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Each year the cost of goods and services that you pay for goes up whether you realize it or not. That's because of inflation. Most recently you can see how the price of gasoline has gone up if you drive. What if gasoline went up 10% next year to aveage $4.40 a gallon? How would that affect your budget? Some more what ifs:

What if your property taxes went up 3% a year?
What if your food costs went up 3% or more each and every year in the future?
What if your phone bill went up 3% ...?
What if your electric, water, natural gas bills went up 3% ...?
What if your auto, health, life insurance went up 3% ....?
What if your medicine, toilet paper, shampoo, laundry detergent went up 3%...?

Anyways, you have to plan for costs going up each and every year!
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Old 08-04-2008, 06:58 PM   #3
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3% might be a low estimate. Including taxes and inflationary effects on top of your expenses, you might need to plan on 7-8% total withdrawal per year from your investments. 4% to live on, 3-3.5% for inflation and .5-1% for taxes.

Of course, that all depends on how closely your spending mimics the CPI-U, which measures a basket of goods and services as consumed by a typical urban worker who rents, doesnt pay their own health care, and spends money on certain things at certain intervals.

If your spending is different from that, your realized inflation may be higher or lower than 3%.
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Old 08-05-2008, 06:53 AM   #4
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Have you used Firecalc yet? You plug in your anticipated first year retirement expenses and it figures how much you will spend with inflation over the course of your retirement. It then evaluates your portfolio to see if it would have survived in the various market fluctuations that have occurred historically. That will give you a good ballpark of where you stand with respect to ER readiness.
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Old 08-05-2008, 07:49 AM   #5
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Yes, including an inflation adjustment is one of the major elements of any retirement plan. 3% inflation cuts your real purchasing power by half in roughly 20 years.

FIRECalc does this for you. Why would you not include it? Just like taxes on your retirement plan distributions, it's real.
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Old 08-05-2008, 07:53 AM   #6
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Originally Posted by cute fuzzy bunny View Post
3% might be a low estimate. Including taxes and inflationary effects on top of your expenses, you might need to plan on 7-8% total withdrawal per year from your investments. 4% to live on, 3-3.5% for inflation and .5-1% for taxes.
7-8%? The inflation increase is based on the withdrawal - so it will be 3-4% of the initial withdrawal. Taxes will be based on the withdrawal amount too.

To the OP: You need to research this before getting too depressed by this new information. I suggest reading some of the posts in the Early Retirement FAQs.
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Old 08-05-2008, 08:06 AM   #7
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Inflation is perhaps the BIGGEST problem for the early retiree. Firecalc is based upon your withdrawing more each year to keep up with inflation. Of course there is the possibility that we could have a long period of high inflation that would exceed the parameters in Firecalcs historical comparisons.
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Old 08-05-2008, 08:58 AM   #8
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7-8%? The inflation increase is based on the withdrawal - so it will be 3-4% of the initial withdrawal. Taxes will be based on the withdrawal amount too.

To the OP: You need to research this before getting too depressed by this new information. I suggest reading some of the posts in the Early Retirement FAQs.
Last time I checked inflation didnt know if your money was withdrawn or not, and thus reduces the value of your portfolio along with your withdrawal money...hence if the entire portfolio doesnt increase by the same rate as inflation or better, you're losing money. Not increasing your withdrawal rate by the same rate of inflation annually means your buying power becomes reduced over time.

Taxes also dont pretend the rest of your portfolio doesnt exist besides your withdrawal. Funds in taxable accounts generate dividends, interest and capital gains. And you're going to have to pay the taxes on those, withdrawn, reinvested, or simply left to accumulate.

So yes, you'll need on average 7-8% returns per year to manage a 4% SWR, cover your inflation losses, and pay your taxes.
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Old 08-05-2008, 09:11 AM   #9
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Last time I checked inflation didnt know if your money was withdrawn or not, and thus reduces the value of your portfolio along with your withdrawal money...hence if the entire portfolio doesnt increase by the same rate as inflation or better, you're losing money. Not increasing your withdrawal rate by the same rate of inflation annually means your buying power becomes reduced over time.

Taxes also dont pretend the rest of your portfolio doesnt exist besides your withdrawal. Funds in taxable accounts generate dividends, interest and capital gains. And you're going to have to pay the taxes on those, withdrawn, reinvested, or simply left to accumulate.

So yes, you'll need on average 7-8% returns per year to manage a 4% SWR, cover your inflation losses, and pay your taxes.
I thought you mentioned that you needed to plan on taking out 7-8% a year. In other words, you take out 4% (let's say 40,000) first year, then at 3% next year should be $41,200, which you don't know what percent it would be. Firecalc and the 4% SWR I believe includes inflation in the calculations, such that portfolios on average return more than 4% so your portfolio should grow during times above inflation and decrease (in real terms) in times during high inflation.

Another way to put it, based off of completely assumptions in the 4% SWR, that after taking out $40,000 (leaving you with $960,000) , a 4.29% return would give you $1,001,200 after the next year where you can take out $41,200 and be left with $960,000 again. Of course over time, it would be more difficult to produce the inflation adjusted number, but it is assumed you will return more than 4.29% per year, so your portfolio will grow. That is where the 4% SWR comes in to play I believe.
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Old 08-05-2008, 09:13 AM   #10
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3% might be a low estimate. Including taxes and inflationary effects on top of your expenses, you might need to plan on 7-8% total withdrawal per year from your investments.
Sure you don't mean 7-8% return per year, so you can increase your SWR by inflation to protect your earning power? Taxes are yet another issue, but I look at them more like an expense, when it comes to withdrawal from qualified accounts.
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Old 08-05-2008, 09:19 AM   #11
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Badly worded. You'll need to increase your withdrawal by the rate of inflation, and improve the value of the portfolio by the same rate.

Or change your lifestyle to mitigate inflation as measured by the CPI on your spending.

Or lose buying power as you age and suck it up. Which works okay if you retire at 70 and die at 82. Not so much if you retire at 40 and live to 90.

But you need an overall average annualized rate of return of between 7 and 8% to maintain an inflation adjusted 4% SWR, or 4-5% "real" rate of return.

My take was that the OP wasnt factoring in inflation to his retirement planning, and it was plausible that he wasnt figuring on taxes either. Those two generally double the amount you need to make every year, and "spend" whether the money is actually dispersed and disappears or gets plowed back into the portfolio to retain its value.
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Old 08-05-2008, 09:39 AM   #12
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Badly worded. You'll need to increase your withdrawal by the rate of inflation, and improve the value of the portfolio by the same rate.
That's better.
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Old 08-05-2008, 09:54 AM   #13
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I'm sorry. I had to pick up the pieces yesterday after being called 'mr mom', and I was still a little scattered until late in the day. I'm also still lamenting my life in poverty.

Its all very depressing.
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Old 08-05-2008, 10:59 AM   #14
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Originally Posted by Rich_in_Tampa View Post
Yes, including an inflation adjustment is one of the major elements of any retirement plan. 3% inflation cuts your real purchasing power by half in roughly 20 years.

FIRECalc does this for you. Why would you not include it? Just like taxes on your retirement plan distributions, it's real.
It seems FIRECalc is something for me to try. I've been mulling over the numbers and looking stuff up online and listening to relevant podcasts of InvestTalk - clearly I have some learning to do before I implement a new plan. I had a kneejerk fear reaction to the idea of working another year, but in the end I think this might be the simplest way to guarantee my comfort throughout retirement.
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