Inflation

Last updated:
September 16, 2021

The term "inflation" refers to the general tendency for prices to go up. "Deflation" is the rare time when prices go down. The basic rule of our current economic society is that prices rise over time. Why? Well, that's a complicated topic that many brilliant people disagree about, so we won't speculate here.

Since prices rise over time, the amount of goods and services you can buy with a fixed amount of cash decreases over time. In personal finance, the rate of inflation in the future is one of many assumptions in a financial plan. The lifestyle you can afford with your retirement nest egg will be more luxurious in a low inflationary period than in a high one, because the purchasing power of your savings will decrease more slowly.

But the fact is, no one knows what the rate of inflation will be in the next quarter or year. Since the late 1980s, inflation has hovered around 3% per year. But in the '70s and '80s, inflation ranged between 5% and 10% for ten years at a time.

In order to deal with the uncertainty around inflation rates, BodesWell removes inflation entirely from our projections. In technical terms, our projected plan is called "Real" as opposed to "Nominal". Another way to say this is that we represent projected income, expenses, investments, and debts in today's dollars. If we project that your income will be $250,000 in 2030, that's an income projection in today's dollars.

There are several benefits to this approach. The most important one is that it makes your retirement saving goals more comprehensible. When we say that your projected Net Worth at age 65 is $3.4 million dollars, those are in today's dollars.

One implication of using real dollars in our projections is that our asset growth projections will grow more slowly than what other financial calculators might show. Historically, an index of S&P 500 stocks has grown at 7% per year. But 3% of that growth is attributable to inflation. If you look at our projections for an S&P 500 index fund, you'll see it grows closer to 4% because we've removed the effects of inflation. In the future, of course, the purchasing power of your future income will decrease as inflation rises. But for planning purposes, using real dollars in our projections simplifies the task at hand. 

In summary, since no one knows the future rate of inflation (or the likelihood of deflation) we've removed this variable from your plan.