Growth & inflation calculation for forecasting 16 January at 2:43PM in Pensions, annuities & retirement planning 31 replies 1.2K views

AIBU

Hi folks
How do people generally forecast growth and inflation in their planning?
Do you: 
(a) use a nett % of growth minus inflation & treat all income at today's value;
or
(b) apply a gross growth % on all assets, treat income (e.g. State Pension) at future inflated value, inflate all costs into the future.
or
(c) do something else?
Any assumptions on growth and inflation are obviously all important and need to be stress tested but I'm interested in the best method.
TIA

SouthCoastBoy

I have two asset classes, equities and cash, and I apply a yearly growth figure, For example this year (FY Apr to Mar) cash growth is modelled at 2%, equity growth -10%, I then forecast this out until I am 95, 

My default growth rates are 3.5% for equities and 1% for cash, I also apply inflation, modelled as 10%,10%,8%, 6%,6% for next 5 years including this FY, with default being 2.5%.

I then adjust my balance to 2020 figures using the inflation factor I have calculated. All my spending that I have projected is in 2020 figures so again use the inflation factor to identify what the actual yearly value will be.

I have made the assumption that the state pension will keep up with inflation so do not adjust that.

Linton

I always work in £ terms with expenditure increasing with inflation and investments increasing with a fixed return. Default inflation is 3% and investment return 4%. Planned expenditure and investment valuations are updated with reality at the end of each tax year.

The planning spreadsheet also calculates tax, so I assume bands increase with inflation but again the values are updated with reality.

SouthCoastBoy

Where applicable I also apply tax albeit incorrectly as currently I assume tax thresholds will never increase. Hopefully they will again at some point!

I'm quite fortunate that less than 50% of my pot is taxable

michaels

I do (a) as thinking in current pounds is easier for me.  I use a real growth of 2% assumption for equities and -2% for cash

billy2shots

I used to overcomplicate things. 

Model investment returns then inflation projected forwards 30/40 years. I compounded investment pot, compounded inflation and worked out my spending needs in 2062. 

Then I thought, what's the point and just base things off today's rate. 
Very simplistic, investment return 6% , inflation 3% so that gives 3% overall return.

Add in costs and taxes if you want to be more specific but that has to be done at today's rates. 

OldMusicGuy

Investment growth, inflation and interest rates are all separate variables that I apply to income and expenditure as appropriate. I can flex each parameter for every year in my 35 year spreadsheet. Maybe complicated but it allows me to do a lot of stress testing which I find helpful before making important long term decisions.

SouthCoastBoy

OldMusicGuy said:

Investment growth, inflation and interest rates are all separate variables that I apply to income and expenditure as appropriate. I can flex each parameter for every year in my 35 year spreadsheet. Maybe complicated but it allows me to do a lot of stress testing which I find helpful before making important long term decisions.

Agree OldMusicGuy, I have similar variables, so I can model worst case scenarios, for example currently I can sustain a 50% decrease in equities over the next 3 years along with inflation running at an average of 7% for the next 5 years. Oddly I focus on the pessimistic models rather than the optimistic.

Albermarle

billy2shots said:

I used to overcomplicate things. 

Model investment returns then inflation projected forwards 30/40 years. I compounded investment pot, compounded inflation and worked out my spending needs in 2062. 

Then I thought, what's the point and just base things off today's rate. 
Very simplistic, investment return 3% , inflation 3% so that gives 3% overall return.

Add in costs and taxes if you want to be more specific but that has to be done at today's rates. 

Investment return 3% with inflation at 3%, gives a real return of 0% ?

sgx2000

I wonder how many people go to the effort to create their own custom spreadsheets?

I suspect a very tiny percentage of the general population......

It would be really interestion to see examples of out peoples spreadsheet to see what I have missed...

SouthCoastBoy

If you're not the recipient of a db pension I don't see how you could make a retirement decision without a spreadsheet