What CPI data is used and how?

[SCook1]

Hi everyone
Hope someone can answer this question.
If I leave the inflation rate as CPI and use, say, a 50-year timespan on the first page, does Firecalc use the CPI data for the past 50 years? If not, how and what CPI data is used for routine Firecalc simulations?
Also I read in a previous thread that headline CPI is used, not core CPI, which I’m assuming is still correct?
Thanks!

 

[SCook1]

To provide a bit more scope: When I use the CPI for inflation I get a much higher success rate than when I enter any steady inflation percentage, even as low as 3%. That’s why I’m wondering.

 

[SecondCor521]

I believe, but am not 100% certain, that FIREcalc uses the CPI historical yearly data.

I believe, but am not 100% certain, that FIREcalc uses total CPI, not core CPI (which IIRC excludes food and energy).

I'm not sure why CPI is working better than a fixed percentage for you. Using the default FIREcalc inputs, CPI and 3% fixed both give about a 95% success rate, but 4% and 5% fixed CPIs are noticeably worse. There could be some temporal correlation between CPI and market returns that a fixed return doesn't have. Or it could be you're looking at time periods where CPI has just averaged around 3%.

 

[Gumby]

I believe, but am not 100% certain, that FIREcalc uses the CPI historical yearly data.

I also believe this to be true, but it is more complex than just taking the last 50 years. What FIREcalc does is, using the set of actual economic data running from 1871 to 2020, including inflation for the year, run as many simulations as your specified time horizon will allow, using all the information you input regarding portfolio amount and composition, spending, pension income, social security etc. So, for example, if you specify 50 years, it starts with the assumption that you are retiring in 1871. It applies the 1871 returns for each asset class, the inflation for 1871 (to determine what your 1872 spending will be), deducts your spending, etc and sees where you are in 1872. Then it applies all the factors from 1872 and so on and so forth until you have gone 50 years, ending in 1920. That is one run. Then it starts again only assuming you retire in 1872 and goes for 50 years, ending in 1921. If keeps doing this until it runs out of data, which means it will run 70 times, the last run will assume retirement starting in 1971 and ending in 2020. Then it determines how many of those runs fail -- that is, where you run out of money before the end. If 7 runs fail out of 70 (10% failure) it will tell you that you have a 90% success rate.

In sum, it applies actual inflation data from the past. It does not anticipate future inflation. If you just plug in 3% inflation, that will be higher or lower than any particular year really was (very unlikely to have been exactly 3% in any year).

Edit to Add: I don't know what inflation measure is used from 1871 to 1912, because I think CPI only goes back to 1913

 

[SecondCor521]

I also believe this to be true, but it is more complex than just taking the last 50 years. What FIREcalc does is, using the set of actual economic data running from 1871 to 2020, including inflation for the year, run as many simulations as your specified time horizon will allow, using all the information you input regarding portfolio amount and composition, spending, pension income, social security etc. So, for example, if you specify 50 years, it starts with the assumption that you are retiring in 1871. It applies the 1871 returns for each asset class, the inflation for 1871 (to determine what your 1872 spending will be), deducts your spending, etc and sees where you are in 1872. Then it applies all the factors from 1872 and so on and so forth until you have gone 50 years, ending in 1920. That is one run. Then it starts again only assuming you retire in 1872 and goes for 50 years, ending in 1921. If keeps doing this until it runs out of data, which means it will run 70 times, the last run will assume retirement starting in 1971 and ending in 2020. Then it determines how many of those runs fail -- that is, where you run out of money before the end. If 7 runs fail out of 70 (10% failure) it will tell you that you have a 90% success rate.

In sum, it applies actual inflation data from the past. It does not anticipate future inflation. If you just plug in 3% inflation, that will be higher or lower than any particular year really was (very unlikely to have been exactly 3% in any year).

Edit to Add: I don't know what inflation measure is used from 1871 to 1912, because I think CPI only goes back to 1913

Right, I thought that your first and second paragraphs went without saying.

As for the very early CPI stuff, I think the FIREcalc people at some point mentioned that they extended CPI back somehow, but I forget the details.

 

[SCook1]

Gumby - Yeah that what I think they’re probably doing too. Thanks for your thoughts.
SecondCore521 - Interesting that the rest of the default inputs yield such a high success rate compared to what I typically put in.
I will play around with it a bit more and see what I can find out. I’ll reply again if I get interesting results.

 

[SCook1]

In sum, it applies actual inflation data from the past. It does not anticipate future inflation. If you just plug in 3% inflation, that will be higher or lower than any particular year really was (very unlikely to have been exactly 3% in any year).

This is why I suspect that the CPI might be more accurate than a fixed inflation entry. However, my success rate is SO much higher using CPI that it spooks me to use it. I fear it might be too optimistic.