Are you including annual increases in contributions in your projections?

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willthrill81
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Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 2:52 pm

Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.

Especially over long-term periods, increasing contributions can make a substantial difference in one's ending portfolio balance. For instance, if $10,000 is saved annually for 30 years at a 5% annual return with no increase in the contributions, the ending value would be $697,608. But if the $10,000 annual contribution were increased by 3% every year, the ending value would be $994,707, a 43% increase compared to flat contributions.

One calculator that allows you to model this and is easy to use is provided by Vanguard, but this only lets you examine the impact of 1% and 2% annual increases in contributions, which may be unrealistically low. This one also limits your savings rate to 25% and the income to $200k.

My favorite calculator is this one by CalcXML. This simple calculator lets you model any increase in annual contributions you wish and even lets you include the impact of tax-drag if you so desire; otherwise, you leave this at 0%.

Since modeling increasing contributions over time will lead to a higher projected ending balance, this might lead some to think that they don't need to invest as much to achieve their desired goals. That's certainly possible, but it may be wise to keep in mind that a number of factors may prohibit you from increasing or even maintaining your contributions over time (e.g. extended unemployment and/or underemployment, increasing expenses, lower than expected inflation).

So what are your thoughts about using increasing contributions in your projections? Are there other calculators you use that allow you to calculate the impact of increasing contributions?
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Re: Are you including annual increases in contributions in your projections?

Post by Jack FFR1846 » Thu May 17, 2018 2:57 pm

I made myself an excel spreadsheet to allow total flexibility. It runs year by year with projections. I can change anything along the way, including any increases by percent or just force a number into it. As the year closes, I replace all projections with actual numbers. This, of course adjusts everything in the future. It allows things like "sell house for smaller house" or "increase insurance because son now making millions and bought dad a Ferrari" as one time events.
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vitaflo
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Re: Are you including annual increases in contributions in your projections?

Post by vitaflo » Thu May 17, 2018 5:34 pm

This is why I only do projections in real terms not nominal. Then you don’t need to worry about stuff like this.
willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Since modeling increasing contributions over time will lead to a higher projected ending balance, this might lead some to think that they don't need to invest as much to achieve their desired goals.
Exactly why I use real numbers. If I assume my spending, income and contributions rise with inflation, then I only need to figure out what the real return of my investments will be. This makes the math simple and I have a much better understanding of "today's value" than I do of "future value". It allows me to make more informed decisions even if my ending balance turns out much greater.
Last edited by vitaflo on Thu May 17, 2018 5:48 pm, edited 1 time in total.

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Re: Are you including annual increases in contributions in your projections?

Post by mortfree » Thu May 17, 2018 5:37 pm

if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...


.

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 5:48 pm

vitaflo wrote:
Thu May 17, 2018 5:34 pm
This is why I only do projections in real terms not nominal. Then you don’t need to worry about stuff like this.
How does doing projections in real terms affect this? I agree that using projected real instead of nominal returns (e.g. 5% instead of 8%) makes sense for returns, but increasing contributions over time is a different matter entirely.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 5:52 pm

mortfree wrote:
Thu May 17, 2018 5:37 pm
if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...
Sure it does. Both 401k and IRA limits increase over time.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by SmallSaver » Thu May 17, 2018 5:56 pm

willthrill81 wrote:
Thu May 17, 2018 5:52 pm
mortfree wrote:
Thu May 17, 2018 5:37 pm
if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...
Sure it does. Both 401k and IRA limits increase over time.
Maybe not in real dollars?

To answer your question OP, I do not factor in future increases in (real) contributions for two reasons. First, I like to make conservative estimates--if they're off I'd rather it be in the good direction. Second, it helps me make decisions about what I should do right now--how much do I need to contribute to get where I want to go?
Last edited by SmallSaver on Thu May 17, 2018 5:57 pm, edited 1 time in total.

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Re: Are you including annual increases in contributions in your projections?

Post by mortfree » Thu May 17, 2018 5:57 pm

willthrill81 wrote:
Thu May 17, 2018 5:52 pm
mortfree wrote:
Thu May 17, 2018 5:37 pm
if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...
Sure it does. Both 401k and IRA limits increase over time.
Agree. I think I was focused on your example of contributing 10,000 so that wasn’t maxing.

Good thread.

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Re: Are you including annual increases in contributions in your projections?

Post by vitaflo » Thu May 17, 2018 6:00 pm

willthrill81 wrote:
Thu May 17, 2018 5:48 pm
vitaflo wrote:
Thu May 17, 2018 5:34 pm
This is why I only do projections in real terms not nominal. Then you don’t need to worry about stuff like this.
How does doing projections in real terms affect this? I agree that using projected real instead of nominal returns (e.g. 5% instead of 8%) makes sense for returns, but increasing contributions over time is a different matter entirely.
If you're projecting one in real terms and the other not, then you're going to get a false projection. You should either be doing it all nominal (both returns and contributions) or all real. If you feel that your contributions will increase faster than inflation, then yes I agree you should take that into account in your projection. But nominal vs real should be consistent across your calculations or you end up with the same problem you outlined in the OP.

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 6:09 pm

SmallSaver wrote:
Thu May 17, 2018 5:56 pm
willthrill81 wrote:
Thu May 17, 2018 5:52 pm
mortfree wrote:
Thu May 17, 2018 5:37 pm
if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...
Sure it does. Both 401k and IRA limits increase over time.
Maybe not in real dollars?
Not in real dollars, no, but if you don't take into account that they do increase in nominal dollars, your projection will be too low because you are projecting that the real value of your contributions will be decreasing by the amount of inflation every year.
SmallSaver wrote:
Thu May 17, 2018 5:56 pm
To answer your question OP, I do not factor in future increases in (real) contributions for two reasons. First, I like to make conservative estimates--if they're off I'd rather it be in the good direction.
If you want to go conservative, then not including increases in contributions may be fine. However, I still think that it's prudent to at least examine what effect a small annual increase in your contributions would have on your projections.
Last edited by willthrill81 on Thu May 17, 2018 6:15 pm, edited 1 time in total.
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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 6:14 pm

vitaflo wrote:
Thu May 17, 2018 6:00 pm
willthrill81 wrote:
Thu May 17, 2018 5:48 pm
vitaflo wrote:
Thu May 17, 2018 5:34 pm
This is why I only do projections in real terms not nominal. Then you don’t need to worry about stuff like this.
How does doing projections in real terms affect this? I agree that using projected real instead of nominal returns (e.g. 5% instead of 8%) makes sense for returns, but increasing contributions over time is a different matter entirely.
If you're projecting one in real terms and the other not, then you're going to get a false projection. You should either be doing it all nominal (both returns and contributions) or all real. If you feel that your contributions will increase faster than inflation, then yes I agree you should take that into account in your projection. But nominal vs real should be consistent across your calculations or you end up with the same problem you outlined in the OP.
By modeling contributions increasing at the rate of inflation and using a projected real return, then the end result will be in real (today's) dollars. How else do you not conflate nominal and real dollars?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by Cycle » Thu May 17, 2018 6:18 pm

Like others, I use today's dollars and today's contributions. When wife got a 40% raise this year and became the bread winner, I just adjusted the contributions up from that point forward. I thought, wow we can retire much sooner!

Shockingly our projected 2% fire date only changed by like a year (10 instead of 11) from that raise, which goes to show in ones 20s how important saving and getting the longest bull market in history is.

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Re: Are you including annual increases in contributions in your projections?

Post by 123 » Thu May 17, 2018 6:43 pm

A problem with including expected annual contribution increases in projections is that they add another source of possible error, those higher contributions may not happen for a variety of reasons. It's another variation of counting your chickens before they hatch. For some folks routinely including future increases in contributions may lead to a bad habit of deciding to "make-up" this year's shortcoming (due to unnecessary new car or additional vacation expenses) by planning to contribute more in future years, and eventually they run out of future years.
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Re: Are you including annual increases in contributions in your projections?

Post by TravelforFun » Thu May 17, 2018 6:44 pm

I use a 3% annual increase in contribution and 6% annual gain to project my asset. I use a spreadsheet to run the numbers.

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Re: Are you including annual increases in contributions in your projections?

Post by IlliniDave » Thu May 17, 2018 6:47 pm

Jack FFR1846 wrote:
Thu May 17, 2018 2:57 pm
I made myself an excel spreadsheet to allow total flexibility.
I pretty much do the same thing for the same reason. My "calculator" is very closely tailored to my situation, both in accumulation and (soon) retirement phasing in SS and pension at appropriate junctures, and a non-uniform withdrawal profile to complement those.

I do all my figgerin' in present dollars/real returns to keep things simple.
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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 6:53 pm

123 wrote:
Thu May 17, 2018 6:43 pm
A problem with including expected annual contribution increases in projections is that they add another source of possible error, those higher contributions may not happen for a variety of reasons. It's another variation of counting your chickens before they hatch. For some folks routinely including future increases in contributions may lead to a bad habit of deciding to "make-up" this year's shortcoming (due to unnecessary new car or additional vacation expenses) by planning to contribute more in future years, and eventually they run out of future years.
Very true.

As a counterpoint, failing to increase one's contributions at least at the rate of inflation can easily lead to lifestyle inflation, thereby increasing your needed portfolio to become financially independent. Due to this, Kitces argues that at least half of any raises you get should be diverted to savings.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by KlangFool » Thu May 17, 2018 6:54 pm

willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.
willthrill81,

Are we that lucky? As far as I can tell, the real wages had been stagnant or going down over the last 10 to 20 years. My nominal income/salary had stayed about the same over the last 10+ years.

Depending on a person's job and industry, most people's salary peak at a certain level and stay stagnant until they retired and/or permanently unemployed or under-employed.

This is my opinion.

A) Many folks are overly optimistic that they can be fully-employed until retirement age.

B) Now, we are adding the assumption that their wages can only go up over a long period of time.

The end result will be many folks will choose to believe that they had over-save for retirement and they need to spend more. Then, we will have a recession to shock many folks into reality.

KlangFool

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 7:07 pm

KlangFool wrote:
Thu May 17, 2018 6:54 pm
willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.
willthrill81,

Are we that lucky? As far as I can tell, the real wages had been stagnant or going down over the last 10 to 20 years. My nominal income/salary had stayed about the same over the last 10+ years.
Luck has nothing to do with it. If one is unable to increase contributions over time due to flat wages, it's most likely to due to essentially zero inflation. In that case, you're 'all square' because your needed financial independence portfolio isn't increasing in size.

Even if real (inflation-adjusted) wages are stagnant, that does not mean that nominal wages are stagnant. Failure to account for this nominal increase in contributions will lead to a pessimistic projection.

If you don't increase your contributions when/if you experience wage growth, you're extending your time to FI.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by KlangFool » Thu May 17, 2018 7:12 pm

willthrill81 wrote:
Thu May 17, 2018 7:07 pm
KlangFool wrote:
Thu May 17, 2018 6:54 pm
willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.
willthrill81,

Are we that lucky? As far as I can tell, the real wages had been stagnant or going down over the last 10 to 20 years. My nominal income/salary had stayed about the same over the last 10+ years.
Luck has nothing to do with it. If one is unable to increase contributions over time due to flat wages, it's most likely to due to essentially zero inflation.
willthrill81,

Do we have zero inflation over the last 10 to 20 years? We don't. What is the global wage trend? As far as I can tell, it is down.

KlangFool

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Re: Are you including annual increases in contributions in your projections?

Post by Jags4186 » Thu May 17, 2018 7:15 pm

I assume my contributions will sharply decrease in the coming years. I’m getting into the “expensive” part of life—home ownership and children on the way.

Fortunately if we never add another dime to our investments and simply survive hand to mouth for the next 35 years we should be okay to retire at 67 with our portfolio + social security. I also hate to say it but the likelyhood is high that we would also inherit some money along the way which would help as well. This of course assumes bottom 10% performance of our portfolio out of a Monte Carlo simulation. If we get 50th percentile returns we could still retire early in our 50s. If we get 90th percentile returns we could theoretically call it quits in our 40s.

We just need to make sure we can cover our expenses year in and year out.

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Re: Are you including annual increases in contributions in your projections?

Post by tibbitts » Thu May 17, 2018 7:19 pm

willthrill81 wrote:
Thu May 17, 2018 7:07 pm
KlangFool wrote:
Thu May 17, 2018 6:54 pm
willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.
willthrill81,

Are we that lucky? As far as I can tell, the real wages had been stagnant or going down over the last 10 to 20 years. My nominal income/salary had stayed about the same over the last 10+ years.
Luck has nothing to do with it. If one is unable to increase contributions over time due to flat wages, it's most likely to due to essentially zero inflation. In that case, you're 'all square' because your needed financial independence portfolio isn't increasing in size.

Even if real (inflation-adjusted) wages are stagnant, that does not mean that nominal wages are stagnant. Failure to account for this nominal increase in contributions will lead to a pessimistic projection.

If you don't increase your contributions when/if you experience wage growth, you're extending your time to FI.
Nominal wages for most people I know have been unchanged for between 5 and 10 years - meaning decreasing real earnings every year.

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 7:30 pm

KlangFool wrote:
Thu May 17, 2018 7:12 pm
willthrill81 wrote:
Thu May 17, 2018 7:07 pm
KlangFool wrote:
Thu May 17, 2018 6:54 pm
willthrill81 wrote:
Thu May 17, 2018 2:52 pm
Rarely discussed on this forum is the impact of increasing contributions over time on one's investments. This might be partially due to that fact that many, probably most, of the investment calculators out there do not allow users to include increasing contributions over time. However, it seems prudent to at least examine this impact at the rate of potential inflation rates (e.g. 2-3%). Other factors beyond inflation may be contributing factors to increasing contributions as well, such as real income going up, debt reduction, etc.
willthrill81,

Are we that lucky? As far as I can tell, the real wages had been stagnant or going down over the last 10 to 20 years. My nominal income/salary had stayed about the same over the last 10+ years.
Luck has nothing to do with it. If one is unable to increase contributions over time due to flat wages, it's most likely to due to essentially zero inflation.
willthrill81,

Do we have zero inflation over the last 10 to 20 years? We don't. What is the global wage trend? As far as I can tell, it is down.

KlangFool
Compared to 10 and 20 years ago in the U.S., real wages have grown slightly according to the Federal Reserve. There certainly hasn't been a decline in real wages. But that's not the point. Let me provide an example.

Let's say that it's 1998, and we're making the median U.S. household income, $38,885. We will assume that 50% of that is being saved, $19442.50 annually.

Fast forward to 2016 (for data purposes), and we're still making the median U.S. household income, $59,039. We've still maintained a 50% savings rate, so we're now saving $29,519.50 annually, more than $10k annually than 18 years earlier.

If we projected our time to FI back in 1998 and just used the $19k dollar amount for all future saving, we would be ignoring the wage growth that occurred along the way. As noted in the OP, this can lead to significant differences in real dollars between what you actually have and what you projected.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by Hillview » Thu May 17, 2018 7:34 pm

I have not (SS calc is really a big one) because my job pays well but raises are very rare

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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 7:36 pm

Hillview wrote:
Thu May 17, 2018 7:34 pm
I have not (SS calc is really a big one) because my job pays well but raises are very rare
So you are constantly falling behind inflation (i.e. negative real wage growth)?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by vitaflo » Thu May 17, 2018 7:46 pm

willthrill81 wrote:
Thu May 17, 2018 6:14 pm
By modeling contributions increasing at the rate of inflation and using a projected real return, then the end result will be in real (today's) dollars.
If I'm reading this correctly, no it won't. If inflation is 100% every year (or something extreme to prove a point) the end result will be an astronomical number. That value will hardly be in *today's* dollars. The purchasing power of your contributions do not change if they go up with inflation. They remain steady. So if you're working in real terms on the return side, you shouldn't count inflation into your contributions either.

The problems I see in most modelers is similar to what you've outlined in the OP. People use a fixed (real) contribution rate but then use a nominal return in their projections. This is a problem.

But you are advocating for the other way, using nominal contribution increases but a real return. It's the same problem just flipped on its head.

So you should be including inflation into your contributions and using nominal returns, or not including inflation into your contributions and using real returns. One or the other.

As another poster pointed out, if you work in real terms you also don't have to guess the future inflation rate. It just makes everything simpler.

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Re: Are you including annual increases in contributions in your projections?

Post by ETadvisor » Thu May 17, 2018 7:50 pm

mortfree wrote:
Thu May 17, 2018 5:57 pm
willthrill81 wrote:
Thu May 17, 2018 5:52 pm
mortfree wrote:
Thu May 17, 2018 5:37 pm
if you're already maxing your 401k and IRA, that annual increase doesn't matter for those buckets...
Sure it does. Both 401k and IRA limits increase over time.
Agree. I think I was focused on your example of contributing 10,000 so that wasn’t maxing.

Good thread.
You have two unknown variables, the amount the limits will increase and the amount of return.

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Re: Are you including annual increases in contributions in your projections?

Post by Hillview » Thu May 17, 2018 8:05 pm

willthrill81 wrote:
Thu May 17, 2018 7:36 pm
Hillview wrote:
Thu May 17, 2018 7:34 pm
I have not (SS calc is really a big one) because my job pays well but raises are very rare
So you are constantly falling behind inflation (i.e. negative real wage growth)?
well it is more complicated than that. for 10 years I was at a large company where I got an average of maybe 3% increase each year. 4 years ago I got a new job that gave me a 33% increase. but there is not a regular annual increase, I am searching for a new job which is likely to result in a pay raise.

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Re: Are you including annual increases in contributions in your projections?

Post by KlangFool » Thu May 17, 2018 8:22 pm

willthrill81 wrote:
Thu May 17, 2018 7:30 pm

Compared to 10 and 20 years ago in the U.S., real wages have grown slightly according to the Federal Reserve. There certainly hasn't been a decline in real wages. But that's not the point. Let me provide an example.

Let's say that it's 1998, and we're making the median U.S. household income, $38,885. We will assume that 50% of that is being saved, $19442.50 annually.

Fast forward to 2016 (for data purposes), and we're still making the median U.S. household income, $59,039. We've still maintained a 50% savings rate, so we're now saving $29,519.50 annually, more than $10k annually than 18 years earlier.

If we projected our time to FI back in 1998 and just used the $19k dollar amount for all future saving, we would be ignoring the wage growth that occurred along the way. As noted in the OP, this can lead to significant differences in real dollars between what you actually have and what you projected.
willthrill81,

Let's carry on your assumption and think about this.

If someone saves 19K from 1998 to 2016 (18 years), it may not matter that much whether the person saves 19K or 29K starting from 2016.

Starting Net Worth $0
Annual Savings $19,000
Years
Annual Return Rate 18
5.00% $534,515
6.00% $587,207
7.00% $645,982
8.00% $711,555
9.00% $784,725

Let's assume 6% nominal. The amount would be about $587,000 at 2016.

The following is the number for 19K

Starting Net Worth $587,000
Annual Savings $19,000
Years
Annual Return Rate 5 10 15
5.00% $854,164 $1,195,141 $1,630,324
6.00% $892,643 $1,301,663 $1,849,023
7.00% $932,562 $1,417,230 $2,097,003
8.00% $973,961 $1,542,534 $2,377,953
9.00% $1,016,882 $1,678,308 $2,695,995

The following is the number for 29K

Starting Net Worth $587,000
Annual Savings $29,000
Years
Annual Return Rate 5 10 15
5.00% $909,421 $1,320,920 $1,846,109
6.00% $949,014 $1,433,471 $2,081,783
7.00% $990,069 $1,555,395 $2,348,293
8.00% $1,032,627 $1,687,399 $2,649,475
9.00% $1,076,729 $1,830,237 $2,989,604

The difference is not as significant as you believe.

It is very simple. Save as much as possible and as early as possible. When your portfolio is big enough, saving more later may not be necessary.

KlangFool

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willthrill81
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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 10:53 pm

KlangFool wrote:
Thu May 17, 2018 8:22 pm
willthrill81 wrote:
Thu May 17, 2018 7:30 pm

Compared to 10 and 20 years ago in the U.S., real wages have grown slightly according to the Federal Reserve. There certainly hasn't been a decline in real wages. But that's not the point. Let me provide an example.

Let's say that it's 1998, and we're making the median U.S. household income, $38,885. We will assume that 50% of that is being saved, $19442.50 annually.

Fast forward to 2016 (for data purposes), and we're still making the median U.S. household income, $59,039. We've still maintained a 50% savings rate, so we're now saving $29,519.50 annually, more than $10k annually than 18 years earlier.

If we projected our time to FI back in 1998 and just used the $19k dollar amount for all future saving, we would be ignoring the wage growth that occurred along the way. As noted in the OP, this can lead to significant differences in real dollars between what you actually have and what you projected.
willthrill81,

Let's carry on your assumption and think about this.

If someone saves 19K from 1998 to 2016 (18 years), it may not matter that much whether the person saves 19K or 29K starting from 2016.

Starting Net Worth $0
Annual Savings $19,000
Years
Annual Return Rate 18
5.00% $534,515
6.00% $587,207
7.00% $645,982
8.00% $711,555
9.00% $784,725

Let's assume 6% nominal. The amount would be about $587,000 at 2016.

The following is the number for 19K

Starting Net Worth $587,000
Annual Savings $19,000
Years
Annual Return Rate 5 10 15
5.00% $854,164 $1,195,141 $1,630,324
6.00% $892,643 $1,301,663 $1,849,023
7.00% $932,562 $1,417,230 $2,097,003
8.00% $973,961 $1,542,534 $2,377,953
9.00% $1,016,882 $1,678,308 $2,695,995

The following is the number for 29K

Starting Net Worth $587,000
Annual Savings $29,000
Years
Annual Return Rate 5 10 15
5.00% $909,421 $1,320,920 $1,846,109
6.00% $949,014 $1,433,471 $2,081,783
7.00% $990,069 $1,555,395 $2,348,293
8.00% $1,032,627 $1,687,399 $2,649,475
9.00% $1,076,729 $1,830,237 $2,989,604

The difference is not as significant as you believe.

It is very simple. Save as much as possible and as early as possible. When your portfolio is big enough, saving more later may not be necessary.

KlangFool
Of course it's not going to make as much of an impact in your example because the annual contributions are less than 6% of the starting balance.

The numbers in the OP show that the difference can be significant. It doesn't hurt to model it to see the difference.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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willthrill81
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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Thu May 17, 2018 11:01 pm

vitaflo wrote:
Thu May 17, 2018 7:46 pm
willthrill81 wrote:
Thu May 17, 2018 6:14 pm
By modeling contributions increasing at the rate of inflation and using a projected real return, then the end result will be in real (today's) dollars.
If I'm reading this correctly, no it won't. If inflation is 100% every year (or something extreme to prove a point) the end result will be an astronomical number. That value will hardly be in *today's* dollars. The purchasing power of your contributions do not change if they go up with inflation. They remain steady. So if you're working in real terms on the return side, you shouldn't count inflation into your contributions either.
If you don't model contributions increasing at the rate of inflation, then you are saying that the real value of your annual contributions is going down by the rate of inflation.

For instance, if I contribute $1,000 this year and 3% inflation occurs across the board, then next year I'll be contributing $1,030, not $1,000. If I was contributing $1,000 back in 1988, I would now need to be contributing $2,140 after adjusting for inflation. This has nothing to do with whether real or nominal rates of return are used; they only account for the rate of growth of my contributions, not how much those contributions actually are.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Are you including annual increases in contributions in your projections?

Post by Nate79 » Fri May 18, 2018 12:19 am

We save as much as we can, live below our means, and resist lifestyle creep. I try to save extra when raises come every year. The projections I use are very basic to make high level conclusions on where we are at.

I don't believe in being too detail oriented in future projections. The error range is too high on too many variables and trying to be this specific is more harmful than helpful as it perpetuates the belief that the projection is valid.
I mean it must be an even more accurate model because I have added one more variable, right?.....

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willthrill81
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Re: Are you including annual increases in contributions in your projections?

Post by willthrill81 » Fri May 18, 2018 12:33 am

Nate79 wrote:
Fri May 18, 2018 12:19 am
I don't believe in being too detail oriented in future projections. The error range is too high on too many variables and trying to be this specific is more harmful than helpful as it perpetuates the belief that the projection is valid.
I mean it must be an even more accurate model because I have added one more variable, right?.....
I'm not sure if the person who knows enough to get this far into projections is going to believe that it's going to be spot on, but perhaps.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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vitaflo
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Re: Are you including annual increases in contributions in your projections?

Post by vitaflo » Fri May 18, 2018 10:49 am

willthrill81 wrote:
Thu May 17, 2018 11:01 pm
vitaflo wrote:
Thu May 17, 2018 7:46 pm
willthrill81 wrote:
Thu May 17, 2018 6:14 pm
By modeling contributions increasing at the rate of inflation and using a projected real return, then the end result will be in real (today's) dollars.
If I'm reading this correctly, no it won't. If inflation is 100% every year (or something extreme to prove a point) the end result will be an astronomical number. That value will hardly be in *today's* dollars. The purchasing power of your contributions do not change if they go up with inflation. They remain steady. So if you're working in real terms on the return side, you shouldn't count inflation into your contributions either.
If you don't model contributions increasing at the rate of inflation, then you are saying that the real value of your annual contributions is going down by the rate of inflation.

For instance, if I contribute $1,000 this year and 3% inflation occurs across the board, then next year I'll be contributing $1,030, not $1,000. If I was contributing $1,000 back in 1988, I would now need to be contributing $2,140 after adjusting for inflation. This has nothing to do with whether real or nominal rates of return are used; they only account for the rate of growth of my contributions, not how much those contributions actually are.
That $2,140 today is still worth $1,000 in 1988. The real value of your contributions over the years does not change if it keeps up with inflation. It's a constant $1,000 in 1988 terms. If you're doing your projections in 1988, that matters.

To me when you're doing projections you are asking one of two questions. 1) What does the value of my portfolio need to be the day I retire? or 2) What does the purchasing power of my portfolio need to be the day I retire?

On #1 you will need to model your contributions increasing with inflation but you will also need to use nominal return values. If you use real returns in this instance you will not be modeling the actual value of the portfolio that you need when you retire. You would be modeling some inbetween value and that can be dangerous. You may be shooting for a number that you end up hitting early because you used a real return projection but got a nominal return in reality. In this case you may think you have "enough" and can retire early but you actually can't.

On #2 the future purchasing power of my portfolio I can know if I use today's dollars only. The only costs I can know are what they are today, not tomorrow. So I need to be always working in today's dollars so I can understand the purchasing power of my investments when I retire, not the actual dollar values of them.

For example, if I spend $40k per year today and want my portfolio to be 25x expenses then I need $1m to retire. But that's $1m in today's dollars. So why are you modeling tomorrows dollars into your contributions when working in today's dollars? All it's going to do (as you alluded to in the OP) is make you think you can save less money to get to said number. In this case you'll end up short at the end. Another problem (and a bigger problem than #1).

At the very least if you disagree with all of this, certainly if you're modeling inflation into your future contribution calculations you are also modeling inflation into your future spending calculations? I would have to assume so or this would make even less sense to me.

wrongfunds
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Re: Are you including annual increases in contributions in your projections?

Post by wrongfunds » Fri May 18, 2018 12:21 pm

"increase insurance because son now making millions and bought dad a Ferrari"
Where do I apply to get a son like that? Oh, is the son beneficiary of the insurance?

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Re: Are you including annual increases in contributions in your projections?

Post by bgf » Fri May 18, 2018 12:32 pm

my wife and I are ~32. i do not project increases in our income. my wife is a high school teacher, and so her salary will increase but not substantially. i am an attorney but not for a large firm or company. i would say my compensation is more likely to increase substantially than her's, but i have no idea by how much or when. or maybe I'll leave the profession and do something else for less money... who knows?

i just assume status quo indefinitely.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

Jags4186
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Re: Are you including annual increases in contributions in your projections?

Post by Jags4186 » Fri May 18, 2018 12:51 pm

No because I'm in a stage of life where my expenses are increasing. Over the next 6-24 months I assume our savings rate will drop from 60% of gross down to 30% of gross assuming we're employed full time throughout.

Shamb3
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Re: Are you including annual increases in contributions in your projections?

Post by Shamb3 » Sat May 19, 2018 8:41 am

As others have said, the decision is going to be based on a lot of details that are particular to you.

For me.No
I already invest through 401k / matching / taxable 40% of my gross income.

I modeled everything in excel with spending and income adjusted for inflation.
Increasing my contributions by inflation in my earnings got me to retirement (maybe) 1 year earlier.
Having that money over the next 15 years is more attractive, so I decided against it.

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