# Do you know your personal inflation rate?

It has never been easy to figure out what your life and your lifestyle will be in the future. Then, again, predictability, often considered an archaic concept in the first place, may never have existed.

Yet, we continue to try to have control over our personal financial lives by using some sort of a measurement to see where we might end up: in the drink, or in the pink.

Numerical calculators generate numbers that estimate the probability of achieving a goal, be it business planning, insuring claims, marketing penetration in a particular demographic, staying on a budget, and of course, considering retirement in our financial future.

Multinational businesses use extraordinarily complex, minutely detailed probability models to provide them with financial results, and most importantly, assurance that, for instance, a particularly significant property and casualty market is viable and profitable.

Those models, I’ve been told, may take days to run before yielding interpretive results.

Individual maths tools (calculators) have existed for many years and are readily found on thousands of financial, investment, savings, and retirement websites. These sites make some significant calculations look very easy, compared to the old days when pen and paper, and possibly a hand-held calculator were used to run up a few savings ideas.

You are asked to input several simple numbers, what you saved now, how old you are, when should you retire, what you currently spend. Those are fairly easy to figure out — we all know what we spend, don’t we? Where these calculators stumble (or possibly we get tripped up) is on the not so easy to predict numbers: The rate of inflation going forward, and the rate of return on investments, and the variability of your personal financial situation on those numbers.

Inflation in an economy is influenced by any number of factors: Demand, supply of goods, cheap money available for loans, and the value of a currency used to purchase those goods and services, and so on.

This inflationary pressure happens across the country economic pathway, but how does inflation actually impact you. I’m sure I don’t have to mention how much more expensive even basic food and personal care items have increased. Still, you only know that you are spending more.

How do you quantify your loss of personal purchasing power? By figuring out what the major items cost in your budget, what proportion they are in your spending play, and how much they increase per year. Sounds complicated, but it is not, although you need to know this when you input your data into any retirement calculator.

Take a look at the chart on this page. Keep in mind this is a generic spending plan. You have to make it work for your life, in order to calculate your personal inflation rate.

Your housing is about 46% or more of your budget, barely going up in cost since the Bermuda economic downturn. Food and personal care 20% of your budget and going up 5% (or more) per year. Only you know by how much!

Look at medical costs. What is the cost of your health insurance in relationship to your total budget, and how much is that cost predicted to climb each year? This generic couple are spending almost 20% of their budget on health costs, while it is increasing 12-15% per year. Politicians will tell you otherwise, but even in the US, health costs have increased 15% per year for more than 25 years.

Transportation and communication costs still increasing — notice the price of gas lately.

So when you calculate what each piece of your budget is taking a piece of that increase in your inflation rate, you arrive at a personal inflation rate of 5.5%.

Almost universally, generic retirement calculators use a 2-3% inflation rate. If your personal budget is outpacing this generic rate, how reliable do you think these numbers are? I’ll tell a secret. It will make your retirement look wonderful, but in reality, it will blow the real predictions of nest eggs and happy times out of the water.

A personal inflation rate is not an easy concept to predict, and that only represents one of the assumptions that you need to make when using retirement calculators.

The second one is: what do you think your investment will earn over time? 3%, 5%, 8%, 10%, 20%, a negative 12%, a negative 2%? Markets do go down. How much risk is attached to those higher end returns?

In the early to late nineties when financial planning was still in infancy in the United States, and markets were booming, climbing ever higher, retirement planners assured clients that they could retire. Their investments were earning 12%, and looking at the sample personal inflation chart, the client was only spending at a 5.5% annual rate. Financial planning was almost a no brainer. Retirement specialists were either geniuses, or not even needed. Plug your own numbers in and presto.

We know now that they were mistaken. When the market crashed in early 2000, many retirees’ dreams vanished into vapourware, and some financial planners were sued for providing inadequate financial advice.

Returning to probability of achievement calculators for retirement plans, it became obvious that one size does not fit all, planning for anything needs constant monitoring and adjustments for the changes in markets, and your own personal financial situation.

Why? Because your personal inflation rate for bears no resemblance to a national or economic inflation rate? Secondly, retirement planners used (and still use) straight line assumptions for that 12% rate of return, year after year, after year. Is that how your life progresses, same thing, year after year?

Martha Myron, CPA CFP (US) TEP JP www.marthamyron.com is an international Certified Financial Planner™ specialising in international tax, estate, and retirement strategies for Bermuda residents with US connections, and US citizens living and working abroad.

Email mmyron@patterson-partners.com or 296 3528 at Patterson Partners Ltd.

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Published Apr 14, 2012 at 8:12 am (Updated Apr 14, 2012 at 8:09 am)

# Do you know your personal inflation rate?

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