Returns and inflation forecasting

Sea_Shell

westv said:

Sea_Shell said:

Do you have to account for inflation on both sides of the spreadsheet?   Both remaining pot "worth" and projected spending?

The money runs out very quickly doing it this way, if sustained.

Should I only be factoring inflation on EITHER pot value or spends, rather than both?   

Definitely one or the other. Not both

So, if one is likely to "make cutbacks" to spending, is it better to account for inflation on the "pot" side of the equation and leave spending at a flat figure?

Or split the difference?

westv

Sea_Shell said:

westv said:

Sea_Shell said:

Do you have to account for inflation on both sides of the spreadsheet?   Both remaining pot "worth" and projected spending?

The money runs out very quickly doing it this way, if sustained.

Should I only be factoring inflation on EITHER pot value or spends, rather than both?   

Definitely one or the other. Not both

So, if one is likely to "make cutbacks" to spending, is it better to account for inflation on the "pot" side of the equation and leave spending at a flat figure?

Or split the difference?

Well I just leave spending as a flat figure and reduce the total pot down by an inflation figure each year. That way I have a better idea of the future value of the pot in today's terms. 
If I was going to make cutbacks in spending then, of course, I would reduce the spending figure if it's not keeping up with inflation.

Sea_Shell

westv said:

Sea_Shell said:

westv said:

Sea_Shell said:

Do you have to account for inflation on both sides of the spreadsheet?   Both remaining pot "worth" and projected spending?

The money runs out very quickly doing it this way, if sustained.

Should I only be factoring inflation on EITHER pot value or spends, rather than both?   

Definitely one or the other. Not both

So, if one is likely to "make cutbacks" to spending, is it better to account for inflation on the "pot" side of the equation and leave spending at a flat figure?

Or split the difference?

Well I just leave spending as a flat figure and reduce the total pot down by an inflation figure each year. That way I have a better idea of the future value of the pot in today's terms. 
If I was going to make cutbacks in spending then, of course, I would reduce the spending figure if it's not keeping up with inflation.

Thanks.   I'll have a play with the figures.

What I'll probably to is up the spends a bit, but then leave it flat.   So allow say £18k rather than £15k.

SouthCoastBoy

I do the following, I have current investments and add a growth figure, so get that in "real" terms. I then take my spending prediction and adjust that by my inflation factor, I use 2020 as my baseline as that is when I calculated my spending requirement for the next 35 years on a yearly basis. This is reviewed monthly.

So for drawdown projections I plug in my 2020 spending figure then adjust that for inflation, so for example if in 2030 I need £2000/mth in 2020 terms I multiply 2000 by the 2030 inflation factor (say 1.5, so actual value is £3000), so that will get me the value i need to take out of my pot in 2030, i then subtract that value from my "real terms" pot, in quotes as only a projection not an actual.

Inflation Factor = Previous Year factor + (Previous Year Factor * inflation /100)

So for example 2021 Previous Year Factor is 1 as 2020 is my baseline and if inflation is 5%

it would be 1 + (1*.05) = 1.05

If 2022 inflation is 6% calculation would be 1.05 + (1.05*.06) = 1.113

I use the same inflation factor for the whole year but do amend it regularly for example for 2022 I'm using 12% inflation , 2023 12% and 2024 10% at the moment, but will adjust accordingly when I get "real figures". 

OldScientist

Some ten year periods in the past have been rather rough. For UK assets (and UK inflation), the close to worst case (1st percentile, 10 year rolling periods from 1872-2016, return and inflation data from https://www.macrohistory.net/database/) real annualised returns were about -7% for stocks, -10% for bonds, -5% for bills (i.e. cash proxy), and -6.5% for a 60/20/20 portfolio (stocks/bonds/cash). However, at the quartile (25th percentile) the real returns are 1.7%, -2.2%, -1.8% for stocks, bonds, bills, respectively and 1.1% for a 60/20/20 portfolio. So taking a return of 0% real lies somewhere between the the 1st and 25th percentiles in historical terms (i.e. bad, but not not as bad as it could have been). Of course, adding some international diversification to a UK portfolio will add a little to the returns (but only a little at the 1st percentile, since many of the worst periods in UK history for returns were due to inflation (e.g. 20% post WWI and, of course, the 70s and 80s).

Like everyone else, I have no absolutely no idea what will happen over the next 10 years, but rather hope things won't be anywhere near as bad as the worst historical cases. 

anonmoose

Thanks OldScientist that is really useful information.

Audaxer

Sea_Shell said:

Do you have to account for inflation on both sides of the spreadsheet?   Both remaining pot "worth" and projected spending?

The money runs out very quickly doing it this way, if sustained.

Should I only be factoring inflation on EITHER pot value or spends, rather than both?   

@Sea_Shell, I think it should only be on one side of the spreadsheet. In your particular case, and mine, maybe it should be on the spending side as I suspect your personal spending is not likely to go up by the official inflation rate? We can't help paying increased prices for energy, food etc. but I suspect that you, I and many others on this site will cut back on spending in these difficult times.

Linton

Sea_Shell said:

westv said:

Sea_Shell said:

Do you have to account for inflation on both sides of the spreadsheet?   Both remaining pot "worth" and projected spending?

The money runs out very quickly doing it this way, if sustained.

Should I only be factoring inflation on EITHER pot value or spends, rather than both?   

Definitely one or the other. Not both

So, if one is likely to "make cutbacks" to spending, is it better to account for inflation on the "pot" side of the equation and leave spending at a flat figure?

Or split the difference?

I find it easier to totally work in £ terms, not real value.  ie increase assumed expenditure with assumed inflation and keep income, assets based on actual vaues at the time.  Income is only increased with inflation where that is guaranteed.  If you want to see what the inflated expenditure etc would mean in current £ terms do that calculation right at the end.

If you want to make a cutback in spending put it as a % in your spread sheet.  It is a basic requirement of my planning that I do not reduce expenditure.  That then is left as an option when all else fails.

Working with £s at 2022 values causes extra hassle when dealing with fixed income and updating/comparing with actuals.

Robert_McGeddon

anonmoose said:

So my assumption is that investment returns will balance out inflation over the next 10yrs. Hopefully add a little more on top but I am not banking on it.

So my question is, is this an OK assumption at this stage or do I need to be using spreadsheets and properly forecasting. I would be expect to be drawing down around 3.5% when the time comes on my figures.

It certainly puts you in the ballpark - if things carry on as-is.  But the next 10 years to retirement is the period whern additional pension pots can most easily be built up.  If you're cutting things a bit fine then consider additional contributions (+ the tax rebate). Once you retire it may be more difficult to get lucrative work to fund your retirement. If in, say, 8 years' time you have more in the pot than you need then retire early!

Perhaps keep in mind non-routine costs, e.g. early retirement due to illness,  a new roof on the house and/or new car or maybe care costs.  A bigger pension pot than the minimum you think you need right now is a good safety net.

At some point between now and retirement you really ought to spredsheet/model your finances in retirement to give certainty (and comfort)  you'll be OK. I found doing the exercise as important as the results because it forced me to consider some life choices as well as underpinning the financials. For me at least, the financial focus changed on retirement. Up to retirement I focussed on building up the pot and spent little effort on working out how to spend it in retirement. Post retirement it's all about managing expenditure.

anonmoose

Thanks Robert, good advice. The light bulb went on several months ago about increasing my pension in these last 10yrs so we are paying the max we can afford.

I am in the lucky position to be paying all my net profit (minus the govt contribution) into my pension. This was made possible by an inheritance allowing us to pay off the mortgage.

So my pot will be more than double what it is now. Also downsizing is part of our strategy so that will give us flexibility if things don't turn out as well as planned. 

We live on a smallholding which I love but it is massively time consuming and a physical tie. When I retire I plan to travel more and our current home isn't compatible with that.

So all in all I think we are in good shape but I can see the need for better analysis further down the track.