Retirement Planner - Importance of Inflation?

GSP

Deleted_User said:

The impact of inflation on long term projections is massive. People can easily be retired for 40 years.

The value of pound has dropped 3.5 times in the last 40 years. That’s with historically low inflation. Go further back, the value of pound dropped by a factor of 50 in 80 years. 

If one wants to plan over a long period of time, he has to account for inflation one way or another. Could be done by counting all costs in today’s pounds and assuming growth in real terms. Projections assuming nominal (Inflated) growth of ones pot and expenditure in today’s pounds are not very meaningful. 

Thanks. Yes I am coming round this has to be factored in. It hard to comprehend at the moment what the cost of fairly basic things will be in 20, 30, 40 years. What can be certain, prices won’t go down.

[Deleted User]

GSP said:

Stubod said:

..I can't see how you can do any long term planning without factoring in inflation?...unless you have no pot to worry about and all your retirement income comes from index linked pensions?

Or alternatively if you are happy that your investments pot will at least keep pace with inflation, in which case you can base everything on today's values?

Thanks. Thinking more, say if my withdrawals were £40k p.a., of that I would say household bills, shopping, running the cars, insurance would be £17k. The rest is holidays, own money to do what we like, presents through the year.
It’s that £17k that needs to be addressed as in it is must money and inflation prone.

Having a pot for discretionary spending and planning to cut expenditure when portfolio underperforms is a good idea. That has nothing to do with inflation. Inflation impacts discretionary and non-discretionary spending. 

Also, sometimes costs in real terms can go up as we get older and require more assistance. 

GSP

Deleted_User said:

GSP said:

Stubod said:

..I can't see how you can do any long term planning without factoring in inflation?...unless you have no pot to worry about and all your retirement income comes from index linked pensions?

Or alternatively if you are happy that your investments pot will at least keep pace with inflation, in which case you can base everything on today's values?

Thanks. Thinking more, say if my withdrawals were £40k p.a., of that I would say household bills, shopping, running the cars, insurance would be £17k. The rest is holidays, own money to do what we like, presents through the year.
It’s that £17k that needs to be addressed as in it is must money and inflation prone.

Having a pot for discretionary spending and planning to cut expenditure when portfolio underperforms is a good idea. That has nothing to do with inflation. Inflation impacts discretionary and non-discretionary spending. 

Also, sometimes costs in real terms can go up as we get older and require more assistance. 

Haha. So many things to think about and I can’t even think about that one. That last one really is a ??
My mum is 91, lives on her own but requires no assistance. She doesn’t spend much at all, but I know she has more than enough. Just one case but building in every factor, are we endangering of being too cautious, too many what ifs to put by, too analytical perhaps?

OldMusicGuy

cfw1994 said:

That’s pretty well the layout of my sheet, as shared with a few on here.  I have a column for the inflation so each year I can adjust it, plus one to apply growth % to the pot each year - allows me to “stress test” a big % drop early on with the main DC pot, for example, but essentially it is this.
Haven’t pulled the trigger yet (another 6 months...), but happy with the broad plan.

That's exactly what I do. It allows me to stress test a whole range of scenarios. I do the same with interest rates on savings as well. It's working really well for me (been retired 2.5 years now).

[Deleted User]

GSP said:

Deleted_User said:

The impact of inflation on long term projections is massive. People can easily be retired for 40 years.

The value of pound has dropped 3.5 times in the last 40 years. That’s with historically low inflation. Go further back, the value of pound dropped by a factor of 50 in 80 years. 

If one wants to plan over a long period of time, he has to account for inflation one way or another. Could be done by counting all costs in today’s pounds and assuming growth in real terms. Projections assuming nominal (Inflated) growth of ones pot and expenditure in today’s pounds are not very meaningful. 

Thanks. Yes I am coming round this has to be factored in. It hard to comprehend at the moment what the cost of fairly basic things will be in 20, 30, 40 years. What can be certain, prices won’t go down.

They might. Deflation is a plausible scenario. A bad one. Terrible for stocks. 

Stubod

GSP said:

Thanks. Thinking more, say if my withdrawals were £40k p.a., of that I would say household bills, shopping, running the cars, insurance would be £17k. The rest is holidays, own money to do what we like, presents through the year.
It’s that £17k that needs to be addressed as in it is must money and inflation prone.

On my spreadsheet I can recognise my outgoings as those that are "essential" and may need a higher level of inflation factored in (eg electric, gas, council tax, food etc), and those that are more discretionary, (eg holidays, cars, etc). I can attribute different inflation figures to both sets. eg essentials may well go up 5% whereas the other stuff may only need to go up by 3%?

Likewise I have 2 columns for my pot, one is for money invested in S&S and the other for cash savings. Again each can have their own percentage for interest. (ie cash is likely to be a little more predictable but a lower rate of return when compared to inflation(?), S&S may deliver more but will be more volatile).

Again all you can really do is update it (annually in my case) with actuals and then run a couple of best case / worst case scenarios and take it from there.

All depends on how detailed / complex you want your spreadsheet to be, but at the end of the day it is all (best) guesswork!...

Sailtheworld

I have a fairly complicated retirement spreadsheet. I run tax year to tax year just to help drawdown projections.

All numbers are in today's money so for investment returns I assume 4% ahead of inflation for equities and 0% for gilts / cash. In terms of spending I have a figure in mind and review this once a year. All calculations based on today's tax / state pension / PCLS rules etc. I think it gives a better feel for whether it's enough if thinking about projected income if it's in today's money.

Everything gets updated once a year when the projected year moves into the past or if a tax band changes etc. I tinker throughout the year and test what if scenarios to make sure the assumptions are still reasonable / correct. Latterly I've been running monte carlo simulations on the investment return assumption and applying standard deviations to see how many times out of a thousand I might fail to meet income targets.

A great function in Excel is the goal seek tool. It allows you to put in the answer you want, say £10k income, and back calculate what investment return you might need or increase in contributions.

GSP

Sailtheworld said:

I have a fairly complicated retirement spreadsheet. I run tax year to tax year just to help drawdown projections.

All numbers are in today's money so for investment returns I assume 4% ahead of inflation for equities and 0% for gilts / cash. In terms of spending I have a figure in mind and review this once a year. All calculations based on today's tax / state pension / PCLS rules etc. I think it gives a better feel for whether it's enough if thinking about projected income if it's in today's money.

Everything gets updated once a year when the projected year moves into the past or if a tax band changes etc. I tinker throughout the year and test what if scenarios to make sure the assumptions are still reasonable / correct. Latterly I've been running monte carlo simulations on the investment return assumption and applying standard deviations to see how many times out of a thousand I might fail to meet income targets.

A great function in Excel is the goal seek tool. It allows you to put in the answer you want, say £10k income, and back calculate what investment return you might need or increase in contributions.

I don’t think my excel 97 will be able to cope with all that!
On another note, I have also been creating my wife’s planner when her drawdown becomes available from 2022. That one should be easier as my pension will pay all the bills and expenditure.

Notepad_Phil

Sailtheworld said:

I have a fairly complicated retirement spreadsheet. I run tax year to tax year just to help drawdown projections.

All numbers are in today's money so for investment returns I assume 4% ahead of inflation for equities and 0% for gilts / cash. In terms of spending I have a figure in mind and review this once a year. All calculations based on today's tax / state pension / PCLS rules etc. I think it gives a better feel for whether it's enough if thinking about projected income if it's in today's money.

One of my spreadsheets is similar to this, however it seems that you don't account for the inflationary impact on savings or have I misread your post? e.g. my spreadsheet might multiply my savings by 0.99 every year for the first bunch of years as I'm a bit of a best interest rate seeker and so I'd hope that I was not too far behind inflation, but I have also done scenarios where I've dramatically raised the dampener to e.g. account for high inflation where interest rates have remained low (which might be where we're heading over the next few years, though I sincerely hope not).

Sailtheworld

Notepad_Phil said:

Sailtheworld said:

I have a fairly complicated retirement spreadsheet. I run tax year to tax year just to help drawdown projections.

All numbers are in today's money so for investment returns I assume 4% ahead of inflation for equities and 0% for gilts / cash. In terms of spending I have a figure in mind and review this once a year. All calculations based on today's tax / state pension / PCLS rules etc. I think it gives a better feel for whether it's enough if thinking about projected income if it's in today's money.

One of my spreadsheets is similar to this, however it seems that you don't account for the inflationary impact on savings or have I misread your post? e.g. my spreadsheet might multiply my savings by 0.99 every year for the first bunch of years as I'm a bit of a best interest rate seeker and so I'd hope that I was not too far behind inflation, but I have also done scenarios where I've dramatically raised the dampener to e.g. account for high inflation where interest rates have remained low (which might be where we're heading over the next few years, though I sincerely hope not).

My base assumption is my cash (or cash like) savings will keep their value against inflation. For equities I assume the same and add 4% which is around the long run real return. 

I think it's the same as what you're doing. You're saying something like you hope to get 1% interest on savings but you need to account for inflation of, say, 1% so you've matched inflation. I'm just dealing with this by saying real returns are zero. To simulate times when rates are low and inflation high I just turn down the real rate of return. I should probably have a negative real return for cash but I don't factor in a lot of cash and I just can't bring myself to do it.