RISP
Recycles dryer sheets
- Joined
- Jul 18, 2012
- Messages
- 407
Over the last several years, I always managed to beat my annual savings targets, despite slowly increasing cost of living (aka inflation) and mostly quite modest pay raises. I wondered why that was the case, so I modeled an example in MS Excel to study this.
All figures in this example are completely fictitious. Say, a household has
- an annual net income of 50,000$.
- They pay 15,000$ towards their mortgage.
- Other expenses total 20,000$,
- leaving 15,000$ for savings/investments.
Now let's assume an inflation rate of 2%, so next year, that household will spend 20,400$, while the mortgage payments remain at 15,000$. I will also assume a salary increase of 2% net, just enough to compensate inflation. My assumption was that this would basically not change our household's economic situation at all. Turns out that is wrong: With a new income of 51,000$ (50,000$ + 2%), expenses of 20,400$ (20,000$ + 2%) and the mortgage payments still at 15,000$, they now have 51,000-20,400-15,000=15,600$ to save/invest, or 4% more. Of course those 15,600$ now are worth only 15,600$/1.02=15,294$ in last year's dollars, but it's still a 1.96% real increase.
The reason for that effect is obviously that the mortgage rate does not increase with inflation. Now, this is probably all very obvious for everyone but me, but I must admit that I was quite surprised.
For my planning spreadsheet, this means that I can budget an increase in my saving rate even if my pay raises only keep up with inflation. Nice.
All figures in this example are completely fictitious. Say, a household has
- an annual net income of 50,000$.
- They pay 15,000$ towards their mortgage.
- Other expenses total 20,000$,
- leaving 15,000$ for savings/investments.
Now let's assume an inflation rate of 2%, so next year, that household will spend 20,400$, while the mortgage payments remain at 15,000$. I will also assume a salary increase of 2% net, just enough to compensate inflation. My assumption was that this would basically not change our household's economic situation at all. Turns out that is wrong: With a new income of 51,000$ (50,000$ + 2%), expenses of 20,400$ (20,000$ + 2%) and the mortgage payments still at 15,000$, they now have 51,000-20,400-15,000=15,600$ to save/invest, or 4% more. Of course those 15,600$ now are worth only 15,600$/1.02=15,294$ in last year's dollars, but it's still a 1.96% real increase.
The reason for that effect is obviously that the mortgage rate does not increase with inflation. Now, this is probably all very obvious for everyone but me, but I must admit that I was quite surprised.
For my planning spreadsheet, this means that I can budget an increase in my saving rate even if my pay raises only keep up with inflation. Nice.