What inflation rate do you use for your planning?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
SpartanBull
Posts: 127
Joined: Fri Jun 06, 2014 12:31 am

What inflation rate do you use for your planning?

Postby SpartanBull » Sun Jan 01, 2017 11:42 am

What inflation rate do you use when your making projections and setting goals? I've seen some varying things on this board. One thing I want to clarify about this question is what I mean by inflation (even though this might be obvious), but I'm referring to the change in value of one dollar. For some reason some people view inflation as like, related to their personal situation/scenario, and I don't think thats the case. If it is, then thats not the type of answer I'm looking for. I understand that your personal expenses might go up less/more than the rate of inflation...I also understand that a Dollar in NYC is worth less than one dollar in Birmingham, Alabama(when your buying things)...but that doesnt change the amount of inflation that occurred. Lastly, I know its not an exact science and we cant know for sure. That being said, what do you use? If you use a hyper conservative/high estimate to play it safe with your savings (I know some people do that), then please indicate that in your reply that your over-estimating it. I'm curious to know peoples best estimate for that they would use for inflation if accuracy is the objective.
A couple of baseline idea I have is
-Historical inflation is 3.2%, I believe.
-The US shoots for 2% I Think?
So, what should one use for planning purposes?

jebmke
Posts: 5641
Joined: Thu Apr 05, 2007 2:44 pm

Re: What inflation rate do you use for your planning?

Postby jebmke » Sun Jan 01, 2017 11:47 am

I don't try to forecast inflation. I do all planning (what little I do) in real terms.
When you discover that you are riding a dead horse, the best strategy is to dismount.

alex_686
Posts: 1631
Joined: Mon Feb 09, 2015 2:39 pm

Re: What inflation rate do you use for your planning?

Postby alex_686 » Sun Jan 01, 2017 11:51 am

Inflation, by economic definition, is a personal relative thing. Most people in the US use the Consumer Price Index (seasonally adjusted) as a proxy. The Bureau of Labor Statistics has statistics broken down by city, region, and type of consumption so you can play with those numbers to your heart's content.

The 10 year government treasury yield is at 2.4%. The 10 Year TIPS is sitting at .5%. So one good guess is that CPI will be at 1.9% for the next 10 years. So below the historical average.

May I ask why you want to do inflation projections?

qwertyjazz
Posts: 935
Joined: Tue Feb 23, 2016 4:24 am

Re: What inflation rate do you use for your planning?

Postby qwertyjazz » Sun Jan 01, 2017 11:53 am

This assumes you buy the CPI basket at equal weights to the model. It is a macro model not micro.
G.E. Box "All models are wrong, but some are useful."

User avatar
bligh
Posts: 279
Joined: Wed Jul 27, 2016 9:13 pm

Re: What inflation rate do you use for your planning?

Postby bligh » Sun Jan 01, 2017 12:01 pm

I use 2%. Lacking a crystal ball, I have to assume the US will manage to succeed at keeping the rate at or around their target rate.
Last edited by bligh on Sun Jan 01, 2017 12:03 pm, edited 1 time in total.

KlangFool
Posts: 5253
Joined: Sat Oct 11, 2008 12:35 pm

Re: What inflation rate do you use for your planning?

Postby KlangFool » Sun Jan 01, 2017 12:03 pm

jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.


+1

KlangFool

lack_ey
Posts: 5230
Joined: Wed Nov 19, 2014 11:55 pm

Re: What inflation rate do you use for your planning?

Postby lack_ey » Sun Jan 01, 2017 12:04 pm

I don't particularly think the historical rate is a good estimate, especially since we know how a lot of that includes much different monetary policy and growth rates.

Quickest and dirtiest method is just a market-based measure, the breakeven inflation rate implied by the difference between nominal Treasury and TIPS yields, as mentioned above. But this is likely not quite right. Nominal Treasuries are riskier for many buyers because of the inflation risk and as such may have a higher yield to compensate for exposing oneself to the risk of unexpected inflation above what everybody thinks is more likely. On the other hand, nominal Treasuries are more liquid than TIPS and thus of greater utility and use to many and should thus have a lower yield. On average perhaps these considerations may roughly balance out but it's not going to be perfect all the time.

You can also check forecasts by economists:
http://projects.wsj.com/econforecast/#ind=cpi&r=20

Or let's say from financial institutions:
Vanguard, as of last month, page 21

User avatar
BolderBoy
Posts: 2745
Joined: Wed Apr 07, 2010 12:16 pm
Location: Colorado

Re: What inflation rate do you use for your planning?

Postby BolderBoy » Sun Jan 01, 2017 12:04 pm

I used 5%. I wanted all my forecasting calculations to use "worst case" type numbers, so high inflation and low returns and no SS. FIREcalc still said I was golden, so I retired.
“Where you stand, depends on where you sit” - Rufus Miles | "Never underestimate one's capacity to overestimate one's abilities"

User avatar
Kevin M
Posts: 8486
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: What inflation rate do you use for your planning?

Postby Kevin M » Sun Jan 01, 2017 12:08 pm

I assume a central tendency of about 2% in the long term, since this is the Fed target. Obviously there is much uncertainty in this, and that should be factored into planning.

Note that there are many different measures of inflation. The Federal Reserve Economic Data (FRED) website lists 107 different series in the Consumer Price Indexes category: Consumer Price Indexes (CPI and PCE) | FRED | St. Louis Fed.

As mentioned by alex_686, you can look at the breakeven inflation rate between nominal Treasuries and TIPS of various maturities to get a sense of the bond market's forecast for inflation over various time periods. There are other factors that affect these spreads (liquidity premium, unexpected inflation premium), but these factors offset each other to some extent, so I think breakeven inflation rates are an OK approximation of market expectations for inflation.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

User avatar
whodidntante
Posts: 1451
Joined: Thu Jan 21, 2016 11:11 pm

Re: What inflation rate do you use for your planning?

Postby whodidntante » Sun Jan 01, 2017 12:08 pm

2%, based on the Fed mandate.

alexost
Posts: 116
Joined: Wed Sep 05, 2012 1:59 pm

Re: What inflation rate do you use for your planning?

Postby alexost » Sun Jan 01, 2017 12:09 pm

I use 3% inflation and believe this is moderately conservative. 3.5% would be more conservative. The FED is shooting for about 2% average inflation. But I don't know if I will be right in the future.

I also forecast my future 20 year return using 6.5% which I believe is conservative. So I'd be forecasting 3 to 3.5% real returns for the next 20 years with an asset allocation of 50% or greater Total Stock market and the remaining Total Bond market.

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: What inflation rate do you use for your planning?

Postby leonard » Sun Jan 01, 2017 12:12 pm

SpartanBull wrote:What inflation rate do you use when your making projections and setting goals? I've seen some varying things on this board. One thing I want to clarify about this question is what I mean by inflation (even though this might be obvious), but I'm referring to the change in value of one dollar. For some reason some people view inflation as like, related to their personal situation/scenario, and I don't think thats the case. If it is, then thats not the type of answer I'm looking for. I understand that your personal expenses might go up less/more than the rate of inflation...I also understand that a Dollar in NYC is worth less than one dollar in Birmingham, Alabama(when your buying things)...but that doesnt change the amount of inflation that occurred. Lastly, I know its not an exact science and we cant know for sure. That being said, what do you use? If you use a hyper conservative/high estimate to play it safe with your savings (I know some people do that), then please indicate that in your reply that your over-estimating it. I'm curious to know peoples best estimate for that they would use for inflation if accuracy is the objective.
A couple of baseline idea I have is
-Historical inflation is 3.2%, I believe.
-The US shoots for 2% I Think?
So, what should one use for planning purposes?


What exactly are you "planning" that requires an estimate of inflation?

My initial thought is that - if one is planning using a critical variable that does in fact vary quite a bit historically - the first step would be setting up the analysis in the right way. For example, doing a monte carlo type analysis to get different outcomes based on different inflation inputs. I think this is more valuable then trying to guess the "right" inflation number to use up front - which is inherently unknowable - and just running with it.

Another approach would be to ignore inflation all together. If I assume my investments have an inflation hedge - stocks or IPS bonds - then perhaps inflation is moot - since I may think I have enough inflation protection built in to my AA.

Again, it depends on what the specific analysis is.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

SpartanBull
Posts: 127
Joined: Fri Jun 06, 2014 12:31 am

Re: What inflation rate do you use for your planning?

Postby SpartanBull » Sun Jan 01, 2017 12:13 pm

While I do a lot planning in real terms as well, the reason I'm curious about this question is its definitely interesting to have an idea of what my "number" is. While its nice to know that "My number is whatever-million in todays dollars 30 years from now", its also interesting to have an idea for that that actual, literal number would be. While using Real-terms is a pretty good indicator, its still in some way, a bit abstract. Its interesting to look at what the actual dollar amount is that you need to retire. While I know its harder to reach that dollar amount early due to the inflation and everything, its interesting to know. For example lets say I want $3,000,000 in todays dollars to retire in 2052. If i use 3%, then my "number" would be 8,441,587.39 I
Also I'm curious, if inflation has been 3.2% historically, is there a high confidence/likelihood to believe it could be kept at or under 2% going forward? That is lower then I thought, because I always just kind of assumed to use the historical average. I know anything is possible, but do you think its more likely that 2% is a better benchmark than 3%?

User avatar
k66
Posts: 360
Joined: Sat Oct 27, 2012 1:36 pm

Re: What inflation rate do you use for your planning?

Postby k66 » Sun Jan 01, 2017 12:17 pm

I use 3% (based on historical data) in order to compute real return projections. I also realize that it may not be what we eventually experience.
LOSER of the Boglehead Contest 2015 | lang may yer lum reek

User avatar
Kevin M
Posts: 8486
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: What inflation rate do you use for your planning?

Postby Kevin M » Sun Jan 01, 2017 12:31 pm

jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.

I can understand doing some planning in real terms, but not all, unless all you invest in are investments like TIPS and I Bonds.

I can understand making expected return estimates in real terms for stocks. There is so much uncertainty in both the nominal return and the inflation rate that you might as well just lump them together and do the estimate in real terms. Also, there are some expected return models that support direct calculation of real expected returns, such as dividend yield plus estimated real earnings growth.

However with nominal fixed income you can't estimate real return without an inflation estimate. I know a CD I own will earn 3% nominal per year for seven years, but if I want to "plan in real terms" and estimate how much purchasing power the CD will have when it matures in seven years, I must factor in an inflation estimate.

If I buy this CD today, I am making an implicit assumption that inflation will be less than about 2.7%, since I could buy a 7-year TIPS with a real yield of about 0.3%. With the spread between the 7-year nominal Treasury and 7-year TIPS at about 2%, I estimate the CD to be a good deal, with a premium of about 0.7 percentage points over the expected inflation built into the nominal Treasury yield.

Kevin
||.......|| Suggested format for Asking Portfolio Questions (edit original post)

jebmke
Posts: 5641
Joined: Thu Apr 05, 2007 2:44 pm

Re: What inflation rate do you use for your planning?

Postby jebmke » Sun Jan 01, 2017 12:37 pm

Kevin M wrote:
jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.

I can understand doing some planning in real terms, but not all, unless all you invest in are investments like TIPS and I Bonds.

I can understand making expected return estimates in real terms for stocks. There is so much uncertainty in both the nominal return and the inflation rate that you might as well just lump them together and do the estimate in real terms. Also, there are some expected return models that support direct calculation of real expected returns, such as dividend yield plus estimated real earnings growth.

However with nominal fixed income you can't estimate real return without an inflation estimate. I know a CD I own will earn 3% nominal per year for seven years, but if I want to "plan in real terms" and estimate how much purchasing power the CD will have when it matures in seven years, I must factor in an inflation estimate.

If I buy this CD today, I am making an implicit assumption that inflation will be less than about 2.7%, since I could buy a 7-year TIPS with a real yield of about 0.3%. With the spread between the 7-year nominal Treasury and 7-year TIPS at about 2%, I estimate the CD to be a good deal, with a premium of about 0.7 percentage points over the expected inflation built into the nominal Treasury yield.

Kevin

That is why I said "what little I do" -- I don't try to plan very much beyond the next 30 days. My "fixed income" is relatively short duration except for some individual Tips so I just make a wet thumb forecast of zero real interest rate for the bond side of my portfolio. This is the only side I try to "forecast" past 30 days since my IRAs are 100% fixed income and I need to come up with some kind of guess about RMDs so I can do ROTH conversions every year.
When you discover that you are riding a dead horse, the best strategy is to dismount.

User avatar
Oicuryy
Posts: 1078
Joined: Thu Feb 22, 2007 10:29 pm

Re: What inflation rate do you use for your planning?

Postby Oicuryy » Sun Jan 01, 2017 12:41 pm

SpartanBull wrote:I know anything is possible, but do you think its more likely that 2% is a better benchmark than 3%?

I do.

The Fed made a public commitment to a 2% inflation target in January 2012. They had never before publicly announced a longer run inflation target.

Inflation has been below 2% since that announcement. Markets seem to be starting to think of 2% as a ceiling rather than an average. I wouldn't want to plan on my investments providing 3% inflation compensation going forward.

Ron
Money is fungible | Abbreviations and Acronyms

User avatar
nisiprius
Advisory Board
Posts: 32958
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: What inflation rate do you use for your planning?

Postby nisiprius » Sun Jan 01, 2017 12:44 pm

I try to do my planning "in real terms." As for Kevin's comments, all of my longer-term fixed-income assets are "real" assets, i.e. inflation-adjusted. All of my "nominal" fixed-income assets are intermediate-term or shorter, and do have a reasonable tendency to follow inflation.

There are problems with planning in "real terms" but they are not anywhere near as bad as trying to guess future inflation rates.

When I need to guess inflation rates for whatever reason, I use 3%, for these reasons:

a) It's a nice round number, without false precision.
b) It's reasonably close to what inflation "used to be" in "the old days," i.e. before the 1970s.
c) It's reasonably close to what inflation has been "ever since then," i.e. after Volcker.
d) It's been a bit on the high side for the last mumble year, and for planning I prefer to err on the safe side.
e) It's within shouting distance of the "historical" number--2.9% for 1926 through 2014, inclusive, according to a book I just glanced at.

But the devil of it is that it's not average inflation that's the problem, and, like every other darn thing in investing, inflation is very "bursty." U.S. inflation history has consisted of long periods of calm interleaved with short periods of high inflation that wreaked havoc on plans. And, no, supposed "inflation hedges" were not good at giving nicely synchronized protective bursts. For example:
The Intelligent Investor, 4th ed., 1973:
Benjamin Graham wrote:(p. 20) On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

taguscove
Posts: 61
Joined: Sun Dec 11, 2016 6:49 pm
Location: cambridge, ma

Re: What inflation rate do you use for your planning?

Postby taguscove » Sun Jan 01, 2017 12:57 pm

I'm surprised that people haven't brought this up. Look up breakeven inflation.

1.81% over next 5 years (https://fred.stlouisfed.org/series/T5YIE)
1.94% over next 10 years (https://fred.stlouisfed.org/series/T10YIE)

Breakeven inflation is calculated from the difference in yield between US Treasury nominal and Inflation linked bonds.
These are two massive and highly liquid asset classes, and reflect the best estimates of a large market of speculators. Short of asking God, I can't think of a better forecast for broad inflation.
-------
By the way, what you're trying to do (forecasting expected returns in real or nominal terms) is really hard, and anyone who has a simple explanation is lying. This is from my perspective working in finance and a hedge fund for 7 years.

The most convincing analysis I've seen is to see how your plan varies with a variety of real investment return assumptions.
I would would personally use 5.5% historic equity real risk premium, 7% above expectations, 3.5% conservative, and 0% worst case. Plans change, but the act of planning is really valuable!
Last edited by taguscove on Sun Jan 01, 2017 1:14 pm, edited 1 time in total.

Sandtrap
Posts: 1167
Joined: Sat Nov 26, 2016 6:32 pm

Re: What inflation rate do you use for your planning?

Postby Sandtrap » Sun Jan 01, 2017 1:01 pm

alexost wrote:I use 3% inflation and believe this is moderately conservative. 3.5% would be more conservative. The FED is shooting for about 2% average inflation. But I don't know if I will be right in the future.

I also forecast my future 20 year return using 6.5% which I believe is conservative. So I'd be forecasting 3 to 3.5% real returns for the next 20 years with an asset allocation of 50% or greater Total Stock market and the remaining Total Bond market.


Thanks "alexost".
Though still a "Boglehead Newbie", those are numbers I'm getting comfortable with. (so far).

User avatar
oldcomputerguy
Posts: 1262
Joined: Sun Nov 22, 2015 6:50 am

Re: What inflation rate do you use for your planning?

Postby oldcomputerguy » Sun Jan 01, 2017 1:04 pm

bligh wrote:I use 2%. Lacking a crystal ball, I have to assume the US will manage to succeed at keeping the rate at or around their target rate.


+1. My planning spreadsheet is set up so that, if inflation varies from my assumption, I can change this in one cell and have the year's expenses track the new value. Gotta start somewhere...
Anybody know why there's a 20-pound frozen turkey up in the light grid?

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: What inflation rate do you use for your planning?

Postby leonard » Sun Jan 01, 2017 1:05 pm

SpartanBull wrote:While I do a lot planning in real terms as well, the reason I'm curious about this question is its definitely interesting to have an idea of what my "number" is. While its nice to know that "My number is whatever-million in todays dollars 30 years from now", its also interesting to have an idea for that that actual, literal number would be. While using Real-terms is a pretty good indicator, its still in some way, a bit abstract. Its interesting to look at what the actual dollar amount is that you need to retire. While I know its harder to reach that dollar amount early due to the inflation and everything, its interesting to know. For example lets say I want $3,000,000 in todays dollars to retire in 2052. If i use 3%, then my "number" would be 8,441,587.39 I
Also I'm curious, if inflation has been 3.2% historically, is there a high confidence/likelihood to believe it could be kept at or under 2% going forward? That is lower then I thought, because I always just kind of assumed to use the historical average. I know anything is possible, but do you think its more likely that 2% is a better benchmark than 3%?


Your "number" then becomes an abstraction that could vary a huge amount - depending on your inflation assumption and the number of years you compound. So, if run your numbers with a return that assumes 5% - it'll be a much different number than at 3% - depending on the number of years you compound. Given that you are developing a plan, what is the decision point based on "the" number(s) calculated in this way?
Leonard | | | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

User avatar
Oicuryy
Posts: 1078
Joined: Thu Feb 22, 2007 10:29 pm

Re: What inflation rate do you use for your planning?

Postby Oicuryy » Sun Jan 01, 2017 1:09 pm

You could also look at the Federal Reserve Bank of Cleveland’s inflation expectations model.

https://www.clevelandfed.org/our-resear ... tions.aspx

Ron
Money is fungible | Abbreviations and Acronyms

alex_686
Posts: 1631
Joined: Mon Feb 09, 2015 2:39 pm

Re: What inflation rate do you use for your planning?

Postby alex_686 » Sun Jan 01, 2017 1:27 pm

Go for real instead of nominal (inflation adjusted).

Calculate your number using 2% inflation over 30 years. Then calculate using a 4% rate. I suspect the 4% number is going to be close to double that of the 2% number. Now, what does this tell you? Not much. I doubt this would change your AA much. The main drivers of your return will be coming from the stock market, your home, and S.S. [edit] Also your human capital, the amount you can contribute towards savings, is also a decent hedge against inflation. These are all decent hedges against inflation. So you are using a number that generates lots of noise and delivers little value.

blinx77
Posts: 171
Joined: Sat Jan 07, 2012 11:23 am

Re: What inflation rate do you use for your planning?

Postby blinx77 » Sun Jan 01, 2017 1:53 pm

Whenever I do planning, I assume 3% inflation whenever I am doing some sort of plan that involves needing to account for inflation. As a prior poster said, it is more conservative than the fed's 2% mandate but in line with historical trends in the U.S., so not an unreasonable choice.

I also assume my equity-heavy portfolio (now 90-10, likely later 80-20 and maybe towards the tail end of the 30 year stretch I use to plan 70-30) will return 5% a year, real (so 8% nominal). This is slightly below historical rates but I understand many economists are forecasting more muted returns going forward. Plus, like the inflation number, it's conservative but not overly so.

It's just back of the envelope. I am sure life will work out differently and so I don't have a retirement "number" yet or even a % of my income that I am targeting for saving. I just try to be responsible where I can while living my life, track and rebalance annually and hope for the best by the grace of God. I've mostly got the lazy portfolio thing down except for a few arcane questions that probably don't matter too much that I ask mostly out of curiosity. Mostly I hang out on the bogleheads because it's one of my preferred sources of free entertainment :D and because people often recommend good consumer products. I'd probably make more money if I spent this time doing some extra homework for my job. Oh well. :sharebeer

The best laid plans of mice and men often go awry, so try to pick some reasonable numbers and know you will never be able to predict the future.

feh
Posts: 1044
Joined: Sat Dec 15, 2012 11:39 am

Re: What inflation rate do you use for your planning?

Postby feh » Sun Jan 01, 2017 2:02 pm

alexost wrote:I use 3% inflation and believe this is moderately conservative.


+1

User avatar
jhfenton
Posts: 1746
Joined: Sat Feb 07, 2015 11:17 am
Location: Ohio

Re: What inflation rate do you use for your planning?

Postby jhfenton » Sun Jan 01, 2017 2:14 pm

I don't. I'm nowhere near retirement, so I don't bother with projections.

If I did, I'd probably use 2%. Given the demographics in the U.S. and the rest of the developed world, I expect developed country inflation to stay low over the long-term.

User avatar
Aptenodytes
Posts: 3734
Joined: Tue Feb 08, 2011 8:39 pm

Re: What inflation rate do you use for your planning?

Postby Aptenodytes » Sun Jan 01, 2017 2:20 pm

KlangFool wrote:
jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.


+1

KlangFool

I'm with jebmke and KlangFool on this one. If you project spending and returns in nominal terms and then project inflation separately, you just magnify the error and uncertainty. Far easier to do everything in real terms, though many of the online calculators make it a bit difficult to play ball.

alexost
Posts: 116
Joined: Wed Sep 05, 2012 1:59 pm

Re: What inflation rate do you use for your planning?

Postby alexost » Sun Jan 01, 2017 2:29 pm

Aptenodytes wrote:
KlangFool wrote:
jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.


+1

KlangFool

I'm with jebmke and KlangFool on this one. If you project spending and returns in nominal terms and then project inflation separately, you just magnify the error and uncertainty. Far easier to do everything in real terms, though many of the online calculators make it a bit difficult to play ball.


Can you show me how you do this? I've often wondered if my method properly captures the inflation adjustment.

My calculations: 20 yrs. nominal return- (1.065)^20 = 3.52 times principal.

20 yrs real return (3% inflation forecast, 6.5% nominal)- (1.035)^20 = 1.99 times principal.
Last edited by alexost on Sun Jan 01, 2017 6:38 pm, edited 1 time in total.

lack_ey
Posts: 5230
Joined: Wed Nov 19, 2014 11:55 pm

Re: What inflation rate do you use for your planning?

Postby lack_ey » Sun Jan 01, 2017 2:37 pm

taguscove wrote:I'm surprised that people haven't brought this up. Look up breakeven inflation.

Just to be that guy, from posts above yours:
alex_686 wrote:The 10 year government treasury yield is at 2.4%. The 10 Year TIPS is sitting at .5%. So one good guess is that CPI will be at 1.9% for the next 10 years. So below the historical average.

lack_ey wrote:Quickest and dirtiest method is just a market-based measure, the breakeven inflation rate implied by the difference between nominal Treasury and TIPS yields, as mentioned above. But this is likely not quite right. Nominal Treasuries are riskier for many buyers because of the inflation risk and as such may have a higher yield to compensate for exposing oneself to the risk of unexpected inflation above what everybody thinks is more likely. On the other hand, nominal Treasuries are more liquid than TIPS and thus of greater utility and use to many and should thus have a lower yield. On average perhaps these considerations may roughly balance out but it's not going to be perfect all the time.

Kevin M wrote:As mentioned by alex_686, you can look at the breakeven inflation rate between nominal Treasuries and TIPS of various maturities to get a sense of the bond market's forecast for inflation over various time periods. There are other factors that affect these spreads (liquidity premium, unexpected inflation premium), but these factors offset each other to some extent, so I think breakeven inflation rates are an OK approximation of market expectations for inflation.

The thread moved quickly, though. Just saying!

User avatar
Watty
Posts: 10272
Joined: Wed Oct 10, 2007 3:55 pm

Re: What inflation rate do you use for your planning?

Postby Watty » Sun Jan 01, 2017 2:56 pm

KlangFool wrote:
jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.


+1

KlangFool


Another +1

I might have missed it but another problem with trying to predict future inflation rate is that inflation could average 3% over the next 30 years but some years will be much higher or lower so you have sequence of returns risk. Since you will be adding or spending each year through the 30 years the order that of high and low inflation years matters a lot.

If you did want to try to predict the future inflation rate then you should also predict it as a range of probabilities. For example (in made up numbers) if you think inflation will be 3% then the correct answer would be that there would be a 80% probability that it will be between 2 and 4 percent and a one percent probability that it will be negative or over 10%.

User avatar
Nearing_Destination
Posts: 570
Joined: Wed Aug 05, 2009 1:26 pm

Re: What inflation rate do you use for your planning?

Postby Nearing_Destination » Sun Jan 01, 2017 7:26 pm

When I did any planning before I used a range:

Inflation of : 2%, 3% , 4%, and 5%

Returns (for portfolio--55/45) of: 2%, 4%, 6%

So as to include negative and positive real returns as possible and under what circumstances failure was likely (5% inflation was the real killer for successful outcome)

gkaplan
Posts: 6716
Joined: Sat Mar 03, 2007 8:34 pm
Location: Portland, Oregon

Re: What inflation rate do you use for your planning?

Postby gkaplan » Sun Jan 01, 2017 8:53 pm

I don't use an inflation rate.
Gordon

User avatar
Aptenodytes
Posts: 3734
Joined: Tue Feb 08, 2011 8:39 pm

Re: What inflation rate do you use for your planning?

Postby Aptenodytes » Mon Jan 02, 2017 2:55 am

alexost wrote:
Aptenodytes wrote:
KlangFool wrote:
jebmke wrote:I don't try to forecast inflation. I do all planning (what little I do) in real terms.


+1

KlangFool

I'm with jebmke and KlangFool on this one. If you project spending and returns in nominal terms and then project inflation separately, you just magnify the error and uncertainty. Far easier to do everything in real terms, though many of the online calculators make it a bit difficult to play ball.


Can you show me how you do this? I've often wondered if my method properly captures the inflation adjustment.

My calculations: 20 yrs. nominal return- (1.065)^20 = 3.52 times principal.

20 yrs real return (3% inflation forecast, 6.5% nominal)- (1.035)^20 = 1.99 times principal.

What you are doing is the opposite of what we do. We skip your step 1 as unnecessary. We simplify your step 2 into "real return = 3.5%/year." There's no need to parse out the real return estimate into separate nominal return and inflation components.

Grogs
Posts: 340
Joined: Tue Mar 24, 2015 4:55 pm

Re: What inflation rate do you use for your planning?

Postby Grogs » Mon Jan 02, 2017 8:59 am

I use real returns as well. The only thing that I can't do that with is my potential pension since it includes no inflation adjustment. I apply a discount of 2.5% per year to represent inflation. I've also run the numbers using 1-5% to see the effects and determine the breakeven time for waiting until full retirement age vs. claiming as soon as I retire with a penalty. With a high enough rate of inflation, the breakeven time goes to infinity.

Quark
Posts: 1045
Joined: Sun Nov 01, 2015 5:32 pm

Re: What inflation rate do you use for your planning?

Postby Quark » Mon Jan 02, 2017 9:10 am

For planning purposes use ranges, not point estimates, for all of your values, including rates of return, spending levels, savings levels, etc.

There's a tremendous amount of uncertainty and reality will differ from your forecasts. Make sure your plans take this into account and that you are aware of what happens if things don't turn out as expected.

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: What inflation rate do you use for your planning?

Postby leonard » Mon Jan 02, 2017 10:25 am

I am still trying to understand what personal planning decision is impacted by assuming inflation is 2.9% versus 3.5% (versus whatever).

What exactly would one do differently as a result of analysis with different inputs? What's the decision point being addressed?
Leonard | | | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

User avatar
Aptenodytes
Posts: 3734
Joined: Tue Feb 08, 2011 8:39 pm

Re: What inflation rate do you use for your planning?

Postby Aptenodytes » Mon Jan 02, 2017 12:25 pm

leonard wrote:I am still trying to understand what personal planning decision is impacted by assuming inflation is 2.9% versus 3.5% (versus whatever).

What exactly would one do differently as a result of analysis with different inputs? What's the decision point being addressed?

Grogs gave one -- if you have a pension that is not adjusted for inflation and you need to estimate your future portfolio withdrawals, you've got to come up with an estimate of the real value of those pension payments.

I can imagine other scenarios where it would matter, though in general I don't think it matters for most people, including me. Perhaps you have all your income streams and portfolio returns available as real returns, but you are planning on some far-off spending on categories that you have strong reason to think will increase in price beyond the overall inflation rate (e.g. education, health care). You might have a good reason to try project inflation rates for those categories (not to say it would be easy, but there'd be a logic to trying).

I'm grateful I don't have to mess with any of that -- projections are fraught enough, having to separately project returns, spending, and inflation would be a mess.

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: What inflation rate do you use for your planning?

Postby leonard » Mon Jan 02, 2017 12:40 pm

Aptenodytes wrote:
leonard wrote:I am still trying to understand what personal planning decision is impacted by assuming inflation is 2.9% versus 3.5% (versus whatever).

What exactly would one do differently as a result of analysis with different inputs? What's the decision point being addressed?

Grogs gave one -- if you have a pension that is not adjusted for inflation and you need to estimate your future portfolio withdrawals, you've got to come up with an estimate of the real value of those pension payments.

I can imagine other scenarios where it would matter, though in general I don't think it matters for most people, including me. Perhaps you have all your income streams and portfolio returns available as real returns, but you are planning on some far-off spending on categories that you have strong reason to think will increase in price beyond the overall inflation rate (e.g. education, health care). You might have a good reason to try project inflation rates for those categories (not to say it would be easy, but there'd be a logic to trying).

I'm grateful I don't have to mess with any of that -- projections are fraught enough, having to separately project returns, spending, and inflation would be a mess.


But, one of the huge risks in such a pension analysis is the very fact you don't know what inflation will be. One needs to test such scenarios under multiple inflation scenarios. Trying to guess at a single, best guess inflation number to plug in to such an analysis won't lead to any actionable decisions - other than possibly the conclusion you need to test more inflation scenarios.
Leonard | | | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

alexost
Posts: 116
Joined: Wed Sep 05, 2012 1:59 pm

Re: What inflation rate do you use for your planning?

Postby alexost » Mon Jan 02, 2017 12:51 pm

Umm. Prudently forecasting assets into the future when you are too old to work much is very useful and responsible- even though we know we may be wrong.

And. Any forecast of future asset value at least implicitly makes a forecast of inflation. I posted earlier about calculating future real asset sums because I know there are nuances in math I may be wrong about when making "inflation adjusted" forecasts, and was hoping a PhD math type would confirm.

If you just "ignore" inflation and say the real 20 year return could be, let's say, 3.5%, is that mathematically the same as saying my nominal return is 6.5% and inflation is 3%?

So let's grow a pile of money, $100,000.00 for 20 years at real 3.5%. 100,000(1.035)^20 = $198,978.00

Now lets grow a pile of money, $100,000.00 for 20 years at nominal 6.5%. 100,000(1.065)^20 = $352,364.00.

Next let's say this forecast was correct in hindsight at the 20 year mark.

Does the difference of the final two 20 year sums correctly calculate the loss of purchasing power lost to inflation? Or is there some nuance in math like arithmetic vs. geometric calculations, or some time series nuance that the simple calculation above does not capture?

I'm asking because even though I think the simple calculation is correct, I am not sure.

Professor???

leonard
Posts: 5993
Joined: Wed Feb 21, 2007 11:56 am

Re: What inflation rate do you use for your planning?

Postby leonard » Mon Jan 02, 2017 1:02 pm

alexost wrote:Umm. Prudently forecasting assets into the future when you are too old to work much is very useful and responsible- even though we know we may be wrong.


is this directed to me in particular (since it followed my post) or the board in general?
Leonard | | | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.

alexost
Posts: 116
Joined: Wed Sep 05, 2012 1:59 pm

Re: What inflation rate do you use for your planning?

Postby alexost » Mon Jan 02, 2017 1:10 pm

leonard wrote:
alexost wrote:Umm. Prudently forecasting assets into the future when you are too old to work much is very useful and responsible- even though we know we may be wrong.


is this directed to me in particular (since it followed my post) or the board in general?


Directed to anyone.

Grogs
Posts: 340
Joined: Tue Mar 24, 2015 4:55 pm

Re: What inflation rate do you use for your planning?

Postby Grogs » Mon Jan 02, 2017 2:55 pm

leonard wrote:
Aptenodytes wrote:
leonard wrote:I am still trying to understand what personal planning decision is impacted by assuming inflation is 2.9% versus 3.5% (versus whatever).

What exactly would one do differently as a result of analysis with different inputs? What's the decision point being addressed?

Grogs gave one -- if you have a pension that is not adjusted for inflation and you need to estimate your future portfolio withdrawals, you've got to come up with an estimate of the real value of those pension payments.

I can imagine other scenarios where it would matter, though in general I don't think it matters for most people, including me. Perhaps you have all your income streams and portfolio returns available as real returns, but you are planning on some far-off spending on categories that you have strong reason to think will increase in price beyond the overall inflation rate (e.g. education, health care). You might have a good reason to try project inflation rates for those categories (not to say it would be easy, but there'd be a logic to trying).

I'm grateful I don't have to mess with any of that -- projections are fraught enough, having to separately project returns, spending, and inflation would be a mess.


But, one of the huge risks in such a pension analysis is the very fact you don't know what inflation will be. One needs to test such scenarios under multiple inflation scenarios. Trying to guess at a single, best guess inflation number to plug in to such an analysis won't lead to any actionable decisions - other than possibly the conclusion you need to test more inflation scenarios.


The point of the pension calculation is to decide to take immediately when you retire at a reduced rate, or wait until you're eligible for the full retirement. For example, under my plan, if I retired at age 55, I could wait until 62, then receive some percentage of my final salary in nominal dollars. Let's call that number X. If I decide to take the pension at 55, I would get 0.65X. X is in nominal dollars, so you're trading off an extra 7 years of pension vs. the reduced rate. If you want to do a breakeven analysis to determine how many years it takes before waiting for the full pension pays off, you have to assume some rate of inflation. If you think inflation will be high, that favors taking the reduced pension immediately. For low inflation, you're better waiting. You can run the calculation with whatever range you want, but you ultimately have to take a guess what it will be and choose appropriately.

User avatar
grabiner
Advisory Board
Posts: 19759
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: What inflation rate do you use for your planning?

Postby grabiner » Mon Jan 02, 2017 5:19 pm

leonard wrote:I am still trying to understand what personal planning decision is impacted by assuming inflation is 2.9% versus 3.5% (versus whatever).

What exactly would one do differently as a result of analysis with different inputs? What's the decision point being addressed?


One issue for me is tax planning, and adjusting my asset allocation accordingly. If the stock market outperforms inflation by 5%, the tax I will owe on my stock investments still depends on inflation. Bonds in a taxable account, even TIPS, would be similarly affected; a TIPS with a 1% yield has a 0.75% after-tax return in a 25% bracket if inflation is zero, but a 0% after-tax return if inflation is 3%.
David Grabiner

DetroitRick
Posts: 300
Joined: Wed Mar 23, 2016 9:28 am

Re: What inflation rate do you use for your planning?

Postby DetroitRick » Mon Jan 02, 2017 7:01 pm

Same as several others have mentioned in this thread, I plan in real dollars. It just makes things simpler. I don't feel I can accurately predict inflation anyway. But I've made an effort to make sure I have adequate inflation protection so that my simple assumption isn't damaging.

KlangFool
Posts: 5253
Joined: Sat Oct 11, 2008 12:35 pm

Re: What inflation rate do you use for your planning?

Postby KlangFool » Mon Jan 02, 2017 8:08 pm

OP and Others,

I really do not see how does inflation rate play in planning at all.

Let's assume your current annual expense = X. Let's assume that your portfolio has some level of REAL RETURN. Let's say it is 2% REAL RETURN. If your portfolio size is between 25X to 40X (pick whatever number that you plan for), you will do fine. Why do you need to care about inflation rate?

KlangFool

User avatar
snowshoes
Posts: 348
Joined: Tue Feb 03, 2015 12:33 pm

Re: What inflation rate do you use for your planning?

Postby snowshoes » Mon Jan 02, 2017 9:16 pm

A known is the FEDs inflation targets. The FED is imperfect. Hyperinflation & inflation happens, its built into all FIAT currencies monetary equation. Cyprus not Greece~(thx VT) recently had a 10% savers confiscation mandate about 2 yrs back. Your question, I use a variable percentage rate of inflation depending on market conditions that equates to more than usual estimates.
Good luck!
Last edited by snowshoes on Sat Feb 11, 2017 4:40 pm, edited 1 time in total.

Church Lady
Posts: 223
Joined: Sat Jun 28, 2014 7:49 pm

Re: What inflation rate do you use for your planning?

Postby Church Lady » Mon Jan 02, 2017 9:58 pm

This discussion is timely for me as I am using I-ORP to run some retirement scenarios. This tool requires users to peer into the crystal ball and tell it what inflation will be over the 30 or 40 years of your retirement. Other such tools have a similar annoying requirement.

If I knew the answer to that, I'd be running a hedge fund ...

This chart is interesting: http://www.usinflationcalculator.com/inflation/current-inflation-rates/
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

User avatar
Phineas J. Whoopee
Posts: 6152
Joined: Sun Dec 18, 2011 6:18 pm

Re: What inflation rate do you use for your planning?

Postby Phineas J. Whoopee » Mon Jan 02, 2017 11:49 pm

snowshoes wrote:A known is the FEDs inflation targets. The FED is imperfect. Hyperinflation happens, Greece had a 10% savers confiscation mandate about 2 yrs back. Good luck!

1) It was Cyprus, not Greece, and prior threads which focused on it were locked;
2) It was only deposits above the insured limit that were partially converted to equity. There, like here, stay below the insured limit and you should be OK; and
3) Fed is not an acronym. It's the commonly-used short form of the name Federal Reserve System. It is possible, but unusual and likely to be misunderstood, to call it the FRS, which is an initialism.
PJW, which is an initialism.
Last edited by Phineas J. Whoopee on Tue Jan 03, 2017 3:56 am, edited 5 times in total.

User avatar
Phineas J. Whoopee
Posts: 6152
Joined: Sun Dec 18, 2011 6:18 pm

Re: What inflation rate do you use for your planning?

Postby Phineas J. Whoopee » Mon Jan 02, 2017 11:55 pm

Not to use the same posting style two posts in a row, except that's what I'm going to do.

1) I forecast expenses in real terms, that they'll be about the same as now after accounting for inflation;
2) I evaluated the risks I face and concluded inflation is the single largest one, although far from being my only risk;
3) I accumulated a large amount of assets relative to my annual expenses; and
4) I chose an asset allocation meant to keep up with inflation over the longer term although I still face sequence-of-returns risk.

The allocation, which my IPS said to, and I did, and I wrote the thing anyway, change to upon achieving a portfolio value equal to thirty five times my present spending:

25% total stock; 15% total international stock; 40% inflation-protected fixed income; 20% nominal fixed income.

I don't know what future inflation will be and can't take it into account. I don't know what my portfolio's returns will be and can't take them into account.

I think my design is reasonable for an asset-heavy investor who needs to defend against inflation risk despite not knowing and not being able to predict.

PJW


Return to “Investing - Theory, News & General”

Who is online

Users browsing this forum: CurlyDave, ftobin and 41 guests