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Author: nhodge One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Inflation in retirement planning Date: 5/28/1998 11:42 PM
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I was just wondering what was the best way to account for inflation in retirement planning calculations. I have several thoughts about this, but I would just like to see what other people on this board do. Thanks.

Neil
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Author: Helter Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3511 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 6:55 AM
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I use a constant 4.5%. I've heard that 3% is a good number to use, but that feels a bit low to me. I also don't plan with the 80% rule that many people advocate, I don't want to spend less when I'm retired, I'll be spending at least as much. Don't interpret that as wasteful, I'm currently saving aggressively, and I don't think I'd like to live on 80% of what I currently spend.

Generally in these calculations, I PLAN with 4.5% inflation and about an 8.5% return. VERY CONSERVATIVE. I enjoy changing my spreadsheets to 12% ROR's and seeing the results, WOW, if I pull that off, I'll be very happy. I'd rather be pleasantly surprised, than fall short of my plan.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3513 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 7:12 AM
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Greetings, Neil, and welcome. You asked:

<<I was just wondering what was the best way to account for inflation in retirement planning calculations. I have several thoughts about this, but I would just like to see what other people on this board do. Thanks.>>

And Helter replied:

Generally in these calculations, I PLAN with 4.5% inflation and about an 8.5% return. VERY CONSERVATIVE. I enjoy changing my spreadsheets to 12% ROR's and seeing the results, WOW, if I pull that off, I'll be very happy. I'd rather be pleasantly surprised, than fall short of my plan.>>

I agree with that response. IMHO it is foolhardy to ignore inflation in retirement. Even at a modest 3%, it could halve one's spending power in 24 years. That's an easily attainable point for many retirees. And FWIW, I use a 4.75% inflation rate coupled with a 9% rate of return. You, though, have to decide the rates that you will use. I always opt for a "conservative" approach to lessen the chances I will be disappointed later.

Regards….Pixy



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Author: nhodge One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3514 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 7:16 AM
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>>I agree with that response. IMHO it is foolhardy to ignore inflation in retirement. Even at a modest 3%, it could halve one's spending power in 24 years. That's an easily attainable point for many retirees. And FWIW, I use a 4.75% inflation rate coupled with a 9% rate of return. You, though, have to decide the rates that you will use. I always opt for a "conservative" approach to lessen the chances I will be disappointed later.<<

Actually, I have a grip on the value issue; I was refering to what you have to multiply by what, and then add to what, etc. (i.e., the actual mathematical implementation). Thanks.

Neil


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3515 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 8:36 AM
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Neil,

<<Actually, I have a grip on the value issue; I was refering to what you have to multiply by what, and then add to what, etc. (i.e., the actual mathematical implementation).>>

Most of us go the simple route by using available calculators that do this for us like this one:

http://www.fool.com/calcs/retcalcs/ret2.htm

But if you want to see an example of the steps involved, just read this link:

http://boards.fool.com/Registered/Message.asp?id=1040013000909009&sort=postdate

Regards....Pixy

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Author: TchrP Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3516 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 9:26 AM
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Pixy, I think I did something wrong the first time I used the calculator, because it predicted that I would leave an estate of $21 million!

After I straightened out some overlapping entries and got a more realistic result, it was especially interesting to see what it projected as the balance at retirement for each source.

In my case, TIAA-CREF accounted for 75% of the balance even though nothing will be added to it. Furthermore, an existing traditional IRA accounted for more than all non-deferred investments, even though the non-deferred investments are currently three times the size of the IRA. And the Roth IRA, new this year, was a very small part even though funds will be added to it in the future.


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Author: Helter Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3517 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 9:30 AM
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I've got my own spreadsheet that I use that has every month in it from now until I'm like 475 years old :).

I enter my current monthly spending in the beginning month. Then I multiply it by 1+(Inflation Rate/12). I realize that this monthly compounding actually results in a slightly higher effective rate of inflation than 'Inflation Rate' but the difference is small.

I use the same 1+(ROR/12) for my investment compounding, so I usually enter 8.45% for growth so my annual is close to 8.5%.

At age 50, I put ='Monthly Expenses'*(-1) to indicate that I begin to completely live off my investments at that point.

I can also use this spreadsheet this way to invest at my current rate each month until I'm 35(10 years), then invest at a slower pace from 35 to 50.

I also have my ROR entered for each month, so I can reduce the ROR once I reach age 40 or 50 or whatever to indicate that some portion of the portfolio will move to 'safer' investments, thus reducing my rate of return.

My only shortfall currently is that my 'current value' column includes both pre-tax and after-tax savings, which I should split out, since my withdrawls between 50 and 67.5 may be greater than my pre-tax amount available.

Mentioning taxes, that's another reason why I use such a low ROR, I figure its reasonable to expect about 8.5% after taxes.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3518 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 11:27 AM
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TchrP,

<<Pixy, I think I did something wrong the first time I used the calculator, because it predicted that I would leave an estate of $21 million!

After I straightened out some overlapping entries and got a more realistic result, it was especially interesting to see what it projected as the balance at retirement for each source.

In my case, TIAA-CREF accounted for 75% of the balance even though nothing will be added to it. Furthermore, an existing traditional IRA accounted for more than all non-deferred investments, even though the non-deferred investments are currently three times the size of the IRA. And the Roth IRA, new this year, was a very small part even though funds will be added to it in the future.>>

Sounds like it has something to do with the rates of return you used for each investment. Also, you might want to note the footnote regarding IRAs. Everything except IRAs uses a monthly contribution, but IRAs use an annual. All I can say without seeing what you did is to ensure you triple check your inputs to ensure they are correct. If you keep getting funny results, you might want to shoot a note to the SmartCalc folks by using the "comments" link at the bottom of the screen. Alternatively, you can send me your assumptions and beginning data and I'll run it to see what the problem may be.

Regards….Pixy


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Author: PSUEngineerFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3519 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 3:31 PM
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Pixy,

Now you have me really confused. Why such a conservative rate of return. It is below the historical return of the market.

Why am I confused? Because we have had several discussions in the past about placing money in taxable accounts versus aftermatch 401K. You stated that before that it may be advantageous to place the money in taxable accounts because the selection of funds in 401Ks may not be good.

Using the formula Ra=Rp/(1-TR), this means your taxable 9% return equates to a 6.48% in a 401K at 28% tax rate. I wouldn't think it would be hard to find one fund in a 401K that returns this.

I see nothing wrong with a conservative approach as I use it myself. No need for surprises. But I do see some conflict between your conservative numbers and the somewhat more aggressive advice you provide in your other answers.

By the way, I like your advice and appreciate your contributions to this folder.

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Author: Helter Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3520 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 4:02 PM
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PSU,


I think it might be a little semantic difference: The advice to contribute to the 401(k) is based on what Pixy 'expects'. Certainly most funds in 401(k)'s will lag the market, but with the match, and an average of 12% for stocks, you can easily expect 11 or 12% or even more for your 401(k) returns. The discussion here was about what you 'plan' for.

Personally I subscribe to 'plan for the worst, hope for the best' when making plans.

When making tradeoff decisions 401(k) vs. taxable, its more prudent to do the calculations with the returns you expect.

Just my thoughts on the difference, I hope I didn't misunderstand your question.

Personally, in my PLAN, I don't even put company matching in the spreadsheet, I consider that part of the rate of return, of course, I contribute the max to my 401(k) because I do expect to get the matching at the end of the year. And the tax avoidance provides wonderful savings at the end of the year.

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Author: PSUEngineerFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3521 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 4:52 PM
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Helter,

No misunderstanding of my question and a good response. Thanks for the input.

Fool on!

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3523 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 5:22 PM
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PSUEngineerFool asked:

<<Now you have me really confused. Why such a conservative rate of return. It is below the historical return of the market.

Why am I confused? Because we have had several discussions in the past about placing money in taxable accounts versus aftermatch 401K. You stated that before that it may be advantageous to place the money in taxable accounts because the selection of funds in 401Ks may not be good.>>

Helter reposited:

<<I think it might be a little semantic difference: The advice to contribute to the 401(k) is based on what Pixy 'expects'. Certainly most funds in 401(k)'s will lag the market, but with the match, and an average of 12% for stocks, you can easily expect 11 or 12% or even more for your 401(k) returns. The discussion here was about what you 'plan' for.

Personally I subscribe to 'plan for the worst, hope for the best' when making plans.

When making tradeoff decisions 401(k) vs. taxable, its more prudent to do the calculations with the returns you expect.>>

Pixy adds:

Yeah, I guess it is confusing at first blush. But Helter hit the nail on the head, and said it much better. By training and temperment I maintain an air of conservatism in long range planning, but I base my immediate actions/decisions on my expectations.

For my retirement stash, I shoot for a pot of money that will sustain an inflation-adjusted income through age 95 using 4.75% inflation and a 9% rate of return. That allows me to have an absolute $$$ target I need to have amassed on the day I retire. That's my focus, so the $$$ target tells me what I have to save annually based on what I can expect to achieve in market returns. I start the annual savings assuming I can just get 9%. In effect, that just forces me to save more than "needed," so the worst that will happen is my target gets reached much sooner. It's rather rewarding to watch the scheduled path and the actual path diverge in my favor because my returns are actually higher than the PLAN calls for.

Poor me…. I've reached a point where I'm seriously considering leaving my day job about three years earlier than Mrs. Pixy expected (or probably wants). But the cash seems to be there and my guess is there's more to life than…….

Regards…..Pixy




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Author: nhodge One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3527 of 74759
Subject: Re: Inflation in retirement planning Date: 5/29/1998 8:17 PM
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Pixy said:

Most of us go the simple route by using available calculators that do this for us like this one:

http://www.fool.com/calcs/retcalcs/ret2.htm

But if you want to see an example of the steps involved, just read this link:

http://boards.fool.com/Registered/Message.asp?id=1040013000909009&sort=postdate

Regards....Pixy

================================================

Actually, I did check out the new calculators on the site, and they are pretty full featured. However, the whole reason for asking the question is so that I could develop my own calcs. Being an engineer, I have an affinity for numbers, and a distrust of anything I can't see the inner workings of. So I'm doing my own.

OK, Pixy, so to summarize, the essence I got from your previous post is that you decrease the "gross" rate of return buy the formula, given as ((1+r)/(1+i)-1), which effectively "subtracts" the rate of inflation from the rate of return, to obtain a "net" (of inflation) rate of return. If I have not understood this correctly, PLEASE let me know. However, this does seem like a reasonable solution. This was my primary thought (to subtract the inflation from the rate of return), but I wanted to confirm it, since it has been a long time since I have studied compounding et. al. seriously.

Pixy, thanks very much for the assistance.

Neil


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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3528 of 74759
Subject: Re: Inflation in retirement planning Date: 5/30/1998 8:17 AM
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Neil,

<<OK, Pixy, so to summarize, the essence I got from your previous post is that you decrease the "gross" rate of return buy the formula, given as ((1+r)/(1+i)-1), which effectively "subtracts" the rate of inflation from the rate of return, to obtain a "net" (of inflation) rate of return.>>

Precisely.

And like you, I do my own as well. Generic calculators are great, but there's no way they can cover every variation. With an understanding of the mechanics involved anyone can quickly construct a spreadsheet or use a financial calculator to illustrate a personal scenario and to play "what if" games. Sometimes the hardest part is just thinking through the variables of the problem.

Regards....Pixy

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