Calculate SWR if CPI is inaccurate?

[ExHermit]

I was hoping CFB would respond to this thread, as he has previously posted thoughtfully on the topic of personal vs. official inflation.

Quote:

Seems to me that most people break into one of two categories: one has a huge portfolio and slogs on without much concern and the other "discovers" that their spending is outstripping their investment returns. The latter effect has been somewhat muted due to a 14 year bull market that was only briefly interrupted by a 2 year bear.

I think I represent a third (maybe rare?) category. I don't have a huge portfolio but I see our spending rate as a variable largely under our control. "ExHermit" is literally true. I know from experience that all you really need is water, food, and clothing and shelter sufficient for the local climate. If you are warm, dry, fed, and not in pain, then you are doing OK. Everything else is gravy. Don't get me wrong, I like gravy. In fact my questions are all about maximizing my gravy supply. The catch is that more gravy is good up to the point that the cost depletes your resources and leaves you feeling deprived later on. Affordable gravy purchases are great fun. Excessive gravy purchases are not good value for money. I am trying to determine, as closely as possible, the break point between affordable and excessive.

Since our small pensions started in 2005, our cash withdrawal rate has been less than 2% of each year's Jan. 1st portfolio balance. It looks like 2007 will come in at about 1.3%. Our total budget, including set asides for amortization of irregular expenses and totally discretionary expenses, is 3.2% of our current portfolio. Pensions currently cover 37.7% of that budget. Social Security, if I start drawing it in 4 years, should cover about 25% of our current budget. For the almost 19 years that I have complete records, our compounded annual investment return has exceeded the compounded annual CPI inflation rate by 6.48%. (I know, I know, way too nerdy about the whole deal.)

I think we are in good shape. In fact I hope we can increase our discretionary spending. The absolute level of future inflation is obviously a factor, but is largely accounted for in Firecalc type calculations. A personal inflation level above the "official" rate is not accounted for in the Firecalc model and has a huge impact on the real value of our (partially) CPI adjusted pensions and on the real value of the SS "pension".

So far I can identify three sources of personal vs. official divergence. 1) Personal expenditure weightings do not match the weightings used in the CPI. 2) The inflation rate in our locality may very from the national urban average. 3) The "improvements" made to the CPI calculations over the years reduce the reported CPI. The CPI seems to have morphed into something other than tracking the cost to maintain a constant standard of living. See Consumer Price Index research series using current methods, 1978-98 Monthly Labor Review - Find Articles
for a discussion of the effect of changes made in 1978-1998.

Items 1 and 2 do not necessarily increase your personal inflation. Over the very long run they might have neutral effect. Item 3 only does one thing, reduce the reported CPI.

Lots to play with here. Probably measuring with a micrometer and cutting with an ax, but a hermit in the north woods gets real good with an ax.

ExHermit

[twaddle]

Quote:

Originally Posted by ExHermit Probably measuring with a micrometer and cutting with an ax....

In the immortal words of CFB, ding ding ding, we have a winnah!

You mentioned that you pulled your 2.5% CPI delta out of thin air, but you also mentioned that you've been tracking your expenses for 19 years. So, you should have a pretty good handle on your CPI delta.

I'm curious. What was the mean and variance of your CPI delta?

I eyeballed my average increase in spending over the last 20 years, and I came up with 12%/year or so. Waaaay over the CPI, but very little of that was due to inflation. And I certainly don't expect to increase my spending at the same rate for the next 20 years.

As I always have, I will continue to adapt my spending to my income.

[SecondCor521]

Quote:

Originally Posted by dbr In Advanced Firecalc under the Options tab you can type in any amount you want for inflation. Did I miss anyone in the postings above pointing this out?

Sorta. My post #7, second paragraph.

2Cor521

[cute fuzzy bunny]

Quote:

Originally Posted by ExHermit Items 1 and 2 do not necessarily increase your personal inflation. Over the very long run they might have neutral effect. Item 3 only does one thing, reduce the reported CPI.

At a ~2% withdrawal rate and champagne desires with an LBYM willingness, you should be fine. Gravy IS good, and should be served in large mugs instead of in "boats". Not that I dont admire the analog.

You've aptly identified three things that an ER needs to pay attention to. As obvious as they are, supposedly expert investors still call CPI adjusted investment products returners of "real" income.

I guess it is, if you've got a pretty flexible definition of "real", with it being equated to "real" for someone who lives somewhere other than where you do, and buys stuff other than what you buy...

The last major adjustment to CPI really WAS a huge thing. It changed a lot of real financial aspects for a retiree, but surprisingly not the expectations. A few divots in your income stream over 20-25 years is a little different from 35-45 years.

It was pretty amusing to read the data on the "CPI-E", which was a CPI index for elderly retirees, which more favors health care costs and other aspects of retired life. IMO a better measure of inflation for the average retired person, and it clocks in at a full 1-2% higher than the CPI. The comments on the folks who reviewed and deep sixed it were telling 'Its a fair measure and more appropriate for retirees than the CPI-U, but we'd go broke if we paid this much out in social security and government pensions, so lets wish it away'.

This while my hero Alan Greenspan claimed that the CPI-U overstated average inflation by 1% or more, and he was raising rates and telling joe sixpack to go get an adjustable mortgage. Theres a book I dont need to buy...

I think the nice round rule of success is that if you're pulling more than 8% in returns, taking less than 4% in withdrawals, and you're willing to be flexible on spending at least during the rough years, you'll be fine. If you structure a portfolio based on CPI indexed securities that pay under 2.5%+CPI and religiously take your 4%, good luck 20-30 years from now when you figure out that the strategy sucked.

Oh and since I mentioned CPI, inflation, TIPS and social security in the same thread...

(P.S. Annuities suck too!)

[ExHermit]

From twaddle

Quote:

You mentioned that you pulled your 2.5% CPI delta out of thin air, but you also mentioned that you've been tracking your expenses for 19 years. So, you should have a pretty good handle on your CPI delta.

I should have made it clear that it is my investments, not my expenses, that I have been tracking in detail for 19 years. I agree with your earlier statement that lifestyle changes completely swamp inflation. I have a good idea what I spent each year, but that has only a voluntary relationship to the Consumer PRICE Index or my personal rate of price inflation. As long as my spending does not approach the minimum required to survive or the maximum I would spend if money was no object, my spending pattern is determined by what I choose to spend, nothing else.

My spending has fluctuated widely, and what I spend it on has changed radically from year to year. My highest ever yearly spending was 11 years ago, the first year I retired, when I was traveling all year on a round-the-world trip. For the last 10 years the change in my total spending, after smoothing out the large year to year fluctuations, has closely matched the CPI change. That is not a coincidence. That is how much I have chosen to spend. My choices may be different in the future, but I am endeavoring to ensure that they will continue to be sustainable choices.


ExHermit