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what do you use for inflation factor in your long term plan?

Posted by celticmoon (My Page) on
Wed, Jan 24, 07 at 0:40

For a long range plan, decades like a reirement plan, I keep seeing 3% suggested for an inflation factor. But that seems too low. You'd have to include the Great Deression years to get the average that low. Or ignore the 70's and just think back short term.

So what do you think? 3.0? 3.5? 4.0?

(I did have acccess to a Monte Carlo simulator for a while, but no longer.)

Or might it be better to think in terms of a spread between inflation and overall investment earnings? There would you use, say, 4%? Higher? Lower?

I find myself leaning toward 3.5 for both. Too conservative? My investments have certainly done way, way, way better than those numbers, but I want to be cautious. I don't want to end up job hunting or eating Alpo in my nineties, you know?


Follow-Up Postings:

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RE: what do you use for inflation factor in your long term plan?

If you use a more conservative (i.e., higher) number, the worst that can happen is that you may end up with too much in your retirement account! Hopefully, that wouldn't be a problem for you.

I have used 4% as my rule-of-thumb for the last few years, but recognize that may not even be enough. You're hearing from someone who considered himself lucky to get a fixed rate mortgage of 10.75 % in 1974 and I take the long view of what can happen. Three percent might not be a bad average number, but if you decide to retire at the same time as the economy tanks for 10 years and inflation jumps, you may feel better if you take a more pessimistic view now of what you have to put away. Averages aren't real comforting when the economy is crappy for an extended period. I, personally, think the chickens will be coming home to roost in a couple of years when all the money that has been blown by the government in the last several years, and our greatly increased national debt start weighing on us. Those who think things are looking rosy should use a low inflation number. Let's check back with one another in 5 years and see who had the best crystal ball....


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RE: what do you use for inflation factor in your long term plan?

If you type "inflation factor" inna Google there will be several sites for just what you want. With calculators.

Interestingly the average rate of inflation was about 4% from the early 30's to now but was 3% from 1900 to now.

Here is just one site: http://www.westegg.com/inflation/


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RE: what do you use for inflation factor in your long term plan?

I'm sorry I wasn't clearer...(nice site and calculator though, Mxplx. I agree that the 3% figure requires the Depression years, as I said in the OP. And given the last two decades, many people accept that figure as reasonable. Scarey.)

I understand inflation pretty well, its variance looking back and the implications for buying power over time - precisely why I want to pick the brains of others who have had to "pick a number".

Kudzu, I hear you. In the 80's, I once was thrilled to get a mortgage of 13.5%!! Yikes. I wonder if the typical young person understands that fixed mortgage rates topped 15% back then? The 80's were rough borrowing times.

So, you chose 4% is your inflation estimate. I could see that. Are you planning 25 years out or more like 50?

Other opinions?

Here is a link that might be useful: historical mortgage rates


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RE: what do you use for inflation factor in your long term plan?

This is one area where I really appreciate having a financial advisor. He has access to some fairly sophisticated software and once a year, we sit down with him and he runs through plugging in various (best case/worst case) figures for inflation so we have a pretty good picture of where we stand and how the next 25-30 years look (depending on both inflation and return on our investments).
I have two printouts right now - one is based on 2.5% inflation and the other on 3.2%. I had asked him to run one based on a worst case (4%), but didn't have it printed out.
I vividly remember getting a 16% mortgage in 1980...(Shiver)


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RE: what do you use for inflation factor in your long term plan?

celticmoon-
I'm using a 25-year horizon...if I'm still around in 50 years, I'l make money from being one of the oldest people in the U.S.! Seriously, if you can get through the next 25 years and have psyched out the economy well enough to have done ok, you should be comfortable.


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RE: what do you use for inflation factor in your long term plan?

zone8grandma, you could do that yourself with Quicken Financial Planner or something similar. It isn't so sophisticated. I'll contrast that process (plugging in an inflation guestimate) with a Monte Carlo simulator. Monte Carlo figures the probabilities for next year's inflation (based on this year's - given inflation moves slowly, probability is higher it will be close to this year's than that it will be several percent higher or lower, right?) Then it runs scenarios with each inflation figure's probability weighted. Got it? So you get a good prediction of what your portfolio would look like end of 2008. Then for 2009, it again determines every possible inflation figure's probability, BUT based off EVERY weighted scenario outcome from 2008. It again generates probability for every inflation possibility, weights those and crunches again, resulting in a most likely picture of end of 2009. And on and on. Kind of like the branching of a tree, each outcome after decades (each leaf?) having finely weighted probabilities over the years. Zillions of computations. Whew. That is what I'd call "sophisticated".

Spits out a clean and simple X percent chance you will or won't have X or more dollars by year 2XXX.

BTW, z8g, 2.5 and 3.2 are hardly "best case, worse case", unless your time line is terribly short. The planner should be making you at least consider 3.5 or 4.0 as a real possibility. Do print out that 4.0 - it may be more realistic than that 2.5 over 30 years. I'm surprised any professional planner would use 2.5. But I may be way off on my thinking. Other opinions?

I wish I still had acess to a Monte Carlo simulator, but I am forced back to the more primitive "pick a number". Remain very interested in what people use.


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RE: what do you use for inflation factor in your long term plan?

I can't do with Quicken Financial Planner what my financial guy does -
I've just looked at the printout and on page29 it says "The projections or other information generated by this retirement analysis with Monte Carlo simulations regarding the likelihood of various investment outcomes are hypothetical in nature, ....." so I guess he's using the Monte Carlo probability simulations referenced above...
It also said that the used probability forecasting based on many different trials or simulations of different market conditions. It went on to say the the simulations provided for expected living expenses 100%. Since our stated objective was 85%, I think we can feel pretty good about DH retiring this year but he still isn't convinced)...
The next time we see him, I'm going to ask him for a printout based on 4% for inflation....


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RE: what do you use for inflation factor in your long term plan?

Thank you for that clarification, z8g. Sounds like he is using a 'monster' Monte Carlo number cruncher. The one I used crunched inflation probability as well as the market return probability. (Link to description of it below). I wonder if his version only looks at investment outcome possibilities, and then he has to fix inflation at this number or that....huh. The Financial Engines one definitely covers both issues.

Your outcome probability does sound excellent!! Can't beat 100% likelihood you'll be OK. On mine a logo showed the sky getting brighter and brighter with a better "forecast". Pretty sunny by 95% - that was as high as I could get it to go.

Good you will look at 3.5 or 4 before DH takes the plunge.

Others out there have an opinion on inflation over time?

Here is a link that might be useful: LA Times description of Monte Carlo simulator


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RE: what do you use for inflation factor in your long term plan?

Yer right Celtic, I didn't read your OP close enough.

That calculator wasn't the one I thot it was; shoulda messed with it B4 recommending it and lookt the others over better. I usually do, not this time. I can't find the one I thot it was.

Sorry about that.
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You know, I'm always suspicious of those high falutin methods. They ALWAYS come down to making your own choice of which of their answers you "feel" right with. Why not just guess in the first place? Its gotta be 3-5. Have you tried taking one of those analyses apart (going into the original derivation) and see just how they're put together?

I took a stock analysis apart oncet. It was a humongously complicated expression for screening a list of stocks. You had to plug all kinds of stuff into it then slide out the answer for each stock. By the time I finished cancelling terms it boiled down to P/E. The guy had just piled stuff on it to make it look sophisticated; fool people.
======================
I passed up a real good deal on a 14.75% mortage in 1981. Maybe it was 12.75% not sure now. Cashed it out instead.


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RE: what do you use for inflation factor in your long term plan?

Well, I followed my own link, and learned that anyone can access a Monte Carlo simulator. Site below is same I had access to years ago as a civil servant as part of a 457 plan. Apparently public access now. With of course a pitch to purchase their advice. (and no, I am not advertising a business in any way connected to me).

So I entered everything and crunched it all - takes a bit to enter and follow the steps, but not too bad. Five years since I last used it. Happy to report we remain on track: >95% chance and sunny skies. Yay.

Myxplx, I think this process is genuinely complex and legit. Founder is a Nobel laureate, and firm contracts with many, many governmental and private entities to advise millions (so says the site). I can attest that they were a perk of my local 457 plan 5 years ago.

z8g, you could crunch your situation with it - inflation factor probabilities are built in. Maybe DH will feel more confident if the results replicate what your planner is telling you.

Thank you both for the interactions. Otherwise I wouldn't have stumbled across the site. Forums never cease to amaze me.

Here is a link that might be useful: Forecast tool


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RE: what do you use for inflation factor in your long term plan?

Some of my clients (and others) 20 years ago chortled at all of the money they were making when Canada Savings Bonds were at 19% about 1981.

They saw those numbers added to their bank account.

Wouldn't believe me when I told them that they had a real rate of return of about 2%.

If they were in 25% income tax bracket, that hauled the 19% down to 14%+, after-tax retention.

Then I asked them whether they knew what the rate of inflation had been - few knew about 12%.

Which meant that they needed to add about that amount to their basic asset in order to maintain purchasing power.

As I've said elsewhere - there are two rats that eat your cheese.

Your partners the income tax people want to talk to you about all of your income, each year - and they want part of it.

The rat called inflation chews a corner off of each dollar of your invested assets each year, as well. Your real rate of return is what's left - quite often, nothing. Or nearly so.

Know what - the rats eat first!

Many financial advisors suggest that as people age, they should invest more of their assets where the principal is pretty well safe - say, at age 80, deduct that from 100 and carry that proportion in safe investments, with only about 20% in the more volatile stuff.

But I'm near 80, and I have about 80% or more in equity-based investments, as I've been playing that game for upwards of 50 years.

If you choose to carry a fairly large proportion of your assets in guaranteed stuff, where the number of dollars that the borrower repays you are guaranteed to be no fewer than s/he borrowed ... they won't be increased by a single dollar, either, apart from the rent that they agreed to pay.

It seems to me that if you choose that route for a substantial portion of your assets, that's the circumstance in which you need to be substantially worried about the ongoing inflation rate.

I've invested in a number of quality stocks, and their value tends to increase faster than inflation, in the main.

And dividend rates tend to increase, in tandem with the stock price.

Which means that I need chew my fingernails much less about the ravages of inflation than do the people who carry a large proportion in "guaranteed" assets.

My fingernails have habit of splitting, as it is - they don't need help from my (non-existent) teeth!

Hope you get things worked out to your long-term satisfaction.

ole joyful


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