How To: Adjust for Inflation

 pexels-photo-187041.jpeg
When your financial plan spans many years, or decades, the effects of inflation become too large to ignore.  I'll explain how and why I adjust for inflation with an example below.

Why?

Let's imagine that you feel pretty comfortable living on $100 per day.  You plan on retiring 50 years from now, and want to maintain that $100 per day lifestyle.  But 50 years from now, $100 might not buy the paper it is printed on, so how can you make an effective plan?  Adjust for inflation.

How?

It's hard work estimating the value of $100; fortunately in the United States the Bureau of Labor Statistics does the work for you by publishing the Consumer Price Index.  I use this table to find the CPI-U of 249.544 for March, 2018, the latest available at the time of this posting.  This number means it took $249.54 in March 2018 to buy the same amount of stuff you could buy in 1982-84 for $100.  Cool.

So how much money do you need to fund your $100 per day lifestyle?  Well, you need enough in your retirement accounts to fund $100 x 365 days = $36,500 per year.  Using the Four Percent Rule, you need $912,500 IN TODAY'S DOLLARS.

To convert money in the future back to today's dollars, multiply by today's CPI (249.544) and divide by the future CPI.  Let's say in 50 years the CPI is 805.123.  You've saved $3 million - but is it enough?

$3,000,000 x (249.544 / 805.123) = $929835.57

You're right on target!  $3,000,000 is called the nominal value of your money.  It has a real value, in 2018 dollars, of about $930,000.

It works the other way, too.  Your $100 per day life style in 2018 translates to

$100 x (805.123 / 249.544) = $323 in 2068 dollars

Conclusion

If your time frame isn't very long, perhaps less than a decade, you probably don't need to worry much about adjusting for inflation.

But if your time frame is long, you should adjust.  Make all your plans in today's (real) dollars and you'll have a clear target.

What do you think?  Do you adjust your goals for inflation?  Would it be helpful to see an example spreadsheet?  Comment below!

One Reply to “How To: Adjust for Inflation”

Share Your Thoughts

This site uses Akismet to reduce spam. Learn how your comment data is processed.