Measuring inflation

kuratowski

When planning retirement, inflation usually gets considered: we talk about after inflation returns on our investments, and about index-linking on SP and DB pensions (for those lucky enough to have them), and we contemplate inflationary increases in our future costs of living.

So I was quite intrigued reading this piece on the FT this week (I think this part of the FT is open access but I have summarised the main point anyway in the quote below):

https://ftalphaville.ft.com/2020/01/24/1579873000000/Why-statisticians-don-t-think-your-iPhone-is-as-expensive-as-you-do/

While Joe Public might see the extra money he pays for this year’s iPhone compared with last year’s model as pure inflation, statisticians see part of that rise as a reflection of innovation — a better camera, say — and discount for it accordingly... This can often lead to higher prices for new, but better quality, products being recorded in the index as deflationary — despite them costing more.

What I took away from this was that the inflation indices used for index-linking (and which we use as a benchmark for measuring returns after inflation on our investments) are likely to be out of step with the kind of inflation we will actually experience in our future cost of living. Hopefully the gap is not too big, after all most things aren't iPhones, but it may be a mistake to assume the two are always equal.

I have yet to decide how to incorporate this idea into my pension planning. Curious to hear others thoughts.

cfw1994

Kind of difficult really. No-one has a crystal ball to know the answer!

I know some base plans on current values and happily ignore inflation.
I think *broadly* speaking, that can be okay, provided you are invested in things that "should" match (or beat!) inflation over the long term/

I know some of my pension pots will change at a differing rates....so I do use a spreadsheet that allows for inflation.
I figure that as years go by, I will drop in "actual" numbers and it can be adjusted as we go.

I do broadly expect a low-inflation few years ahead, but I also recall paying mortgage rates of 15% at one time:eek:
(& I'm not an IFA or economist, so my opinion is as bad as most here!)

MarkCarnage

It kind of depends on the weighting placed on these items in the overall 'basket' of goods and services used to calculate RPI/CPI.

I suspect that they are relatively low, but and whilst not insignificant, unlikely to be a game changer. Also, if the technical advances mean longer or more reliable product life, then it is probably deflationary.

Brilley

For long term planning purposes I have always assumed (on my spreadsheets), that inflation will always be greater than any interest on either savings or investments and will also slightly exceed pension increases.
eg whatever the inflation figure is, any index linked pensions will be 85% of this figure and savings will be 50% of the inflation figure....just trying to play it safe.

kuratowski

MarkCarnage wrote: »

It kind of depends on the weighting placed on these items in the overall 'basket' of goods and services used to calculate RPI/CPI.

You are right of course. However I looked into a bit further and nearly all products have some kind of quality adjustments applied, not only technology. Albeit the impact is obviously greater for technology.

@Brilley That sounds like something I should consider too.

Thrugelmir

kuratowski wrote: »

What I took away from this was that the inflation indices used for index-linking (and which we use as a benchmark for measuring returns after inflation on our investments) are likely to be out of step with the kind of inflation we will actually experience in our future cost of living. Hopefully the gap is not too big, after all most things aren't iPhones, but it may be a mistake to assume the two are always equal.

Inflation is a personal matter. Much depends on ones own discretionary spending. As you age you will most likely have less desire to buy and replace. Constant replacement is a marketing tool and often an outcome of poor build quality.

Albermarle

Inflation is a personal matter. Much depends on ones own discretionary spending

Yes the published inflation rate is a blanket figure .
In the past different socio-economic groups have complained that the inflation rate they are seeing is much more than the official figure .
For example poor people will have a much larger part of their spending on basic things , like food and energy , whilst being unaffected by say the cost of flights or new cars .

DairyQueen

I recall a couple of years ago a thread that focused on personal inflation rate. It proved to be a good opportunity to closely inspect the representative items from the 'basket of goods' referred to by MarkCarnage. The detail proved surprising and I doubt that the official rate is experienced by many.

The majority of posters concluded that it was impossible to calculate individual inflation rate so best use RPI/CPI for planning purposes.

The mention of a change in discretionary spending in later years resonated with me. The compulsion to replace has receded dramatically.

For example, unlike my younger self, I have no need nor desire to replace my mobile phone every couple of years. Likewise, I expect that my 7-year-old car (mileage yet to exceed 22,000 miles) will continue its sterling reliability and functionality for several more years. Clothing? Spending has dropped dramatically.

Housing costs OTOH seem to increase at a rate much higher than official inflation. Our council tax will be rising by 4% this year.

MarkCarnage

Housing costs OTOH seem to increase at a rate much higher than official inflation. Our council tax will be rising by 4% this year.

This is only included in CPIH, not regular CPI. It is included in RPI, probably another reason the Government want to remove RPI! (The valid reason is that the statistical methodology is !!!!).

michaels

I think a bigger issue may be the difference between cpi/rpi/cpih or whatever and average wages resulting in a seemingly reasonable retirement income becoming a distinctly poor one over a 30+ year retirement.

For example you could retire with a median household income but after 30 years easily be in the bottom quartile if your income had gone up with CPI whilst the median had gone up with average wages.

Think about it - you retire and you are about half way up the income distribution, you reach your 80s, your purchasing power remains the same so you are not 'worse off' in terms of what you can but suddenly 75% of people are earning and spending more than you, you can't afford to buy your grand kids a trip to the moon for their birthdays whilst almost everyone else it seems can afford it, you might well feel pretty poor.

hugheskevi

Some very good points above.

I expect my State Pension to increase by at least CPI, my DB pensions to increase by CPI, and investments (after charges) to increase by at least CPI.

I calculate my income needs escalating in line with average earnings (4.2% in long-run, as measured by OBR) until age 70 (highest reasonable State Pension age), and then by CPI. By age 70 I expect all of my income to come from DB and State Pensions, so that is increasing by a minimum of CPI and probably slightly more.

I plan to carry no debt into retirement and own my property, to minimise income needs and hence risk/volatility. As far as possible, I'll reduce expenditure needs prior to retirement (medical tests, procedures, etc), further reducing risk/volatility.

Hopefully all the above will ensure sufficient income/resources, with as little volatility on expenditure needs as possible. Not a perfect risk reduction, but about as good as I can make it.