Inflation question...I think

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JJBean
Posts: 3
Joined: Thu May 01, 2014 4:16 pm

Inflation question...I think

Post by JJBean »

Hello,

I have a question I would like help spitballing.

When I retire in a couple years I will have a FED govt retirement at about 2x annual expenses. So, I really think my future risks and successful retirement revolve around 1. Govt default and 2. Inflation

1. I really doubt the govt will hard default..meaning they just stop paying pensions. I think more likely they will do a soft default if needed where they just keep increasing the money supply and don't keep retirements payments on par (theoretically my retirement will be inflation adjusted) So really, I think there is just one big threat- inflation. Yes, there always could be an EMP attack or civil war where obligations of the previous govt are not honored etc. etc. However, those events, while possible, seem remote and even tougher to prepare for in a way that all life will not be disrupted.

Low continuous inflation, as desired by the Federal Reserve, is hard enough to plan for, but actual high inflation is very difficult to deal with. My general thoughts about how to possibly deal with the threat of inflation over time:
1. Multigenerational living- from what I can tell this has been the solution the world over for all time. Always have people making current dollars in the household. So, I bought a house that can be easily split into 3 separate apartments. Whether any of my kids would want to live with me is an known unknown at this point. I am sure it is not their fairytale dream at this point:)
2. Paid off modest home in a low property tax state. Some people fear paying income taxes in their retirement. If I am paying significant income taxes in retirement, then I figure I have "won." as I must be earning a decent amount of money. Taxes not tied to income scare me more in retirement.
3. Commodities. I wish I could bank fuel and everything else I would need, but it is honestly not very realistic. Gold and Silver are good as a store of value, however.
4. I have been working on my gardening skills. I figure there is no money in farming (growing more than I can use to sell at market), but a lot of money in gardening. Anything I grow and eat myself I figure is the equivalent of "selling" to myself at 150% of the market rate as I would have to buy that food with post tax dollars. All the tools etc do not really wear out either which is a bonus.
5. Having a wood lot for firewood would be one way to use todays dollars to pay for future expenses. However, I somewhat expect the govt to outlaw burning your own wood at some time. Also, living in a more moderate climate makes that not even that useful. However, living close enough to somewhere I can fish might make sense.
6. Stock market. I am not sure if the stock market really grows over time or if it just captures the extra dollars created and thus goes up. Discussion way beyond this thread. However, even if the stock market does not really grow, but just captures inflation, that could be a really important thing in my position.
-my current skillset pays well, but would be prohibitively hard to get back into once I retire. So, when I call it quits, I need to be sure or I will have to supplement with substitute teaching or walmart staff or some other less well remunerated jobs.

That is about all my ideas of how to prepare for the future. All your thoughts regarding 1. Is my only real risk inflation? and 2. any ideas regarding how to prepare for it are appreciated.

Generation-X
Posts: 50
Joined: Mon May 06, 2013 4:43 am

Re: Inflation question...I think

Post by Generation-X »

Here's another way to evaluate.

For pension, the risk is not receiving payment while alive due to some unforeseen event.

The problem - do you take the pension or lump sum?

To help evaluate, we look to the stock market.

Many say the average compound annual return of the US stock market from 1926 to 2017 was about 10 percent including inflation (if 4% inflation, then 6% real return).

so 10% seems like the magic number. If you already know your monthly pension income amount after retirement, then annualize it (monthly pension income x 12) then divide that number by your total pension contribution.

i.e.:

Monthly pension income after retirement - $3000 / mo.
Monthly pension income after retirement annualized - $36,000 / yr
Your total pension contribution - $200,000

pension after retirement (annualized) / Total pension contribution = 36,000 / 200,000 = 0.18 or 18%

18% is greater than historical stock market return of 10% so the pension may be the way to go. You are getting 18% return on your investment. Break-even is (1/.18)= 5.555 years. After 5.555 years you've made even money.

The follow up question is, what is the chance of total loss on the investment? If total loss occurs, can you take that loss?

What is the percentage of the pension contribution to your total net worth?

If total loss occurs immediately after retirement, and say if you have 1 million in net worth, then $200,000 total pension contribution equals 20% loss. We look to the drawdown table:

Image

According to the table, 25% gain is needed to recover 20% loss, which will take about 2.341 years if the market returns more than 10% in 3 consecutive years. Maybe doable.

On the otherhand, if you have 500k net worth, then 200k total pension contribution equals 50% loss. The drawdown table says 100% gain is needed to recover 50% loss, which will take about 7.273 years if market returns more than 10% in 8 consecutive years. Probably not likely.

Here's a histogram of market returns from 1926 - 2017.

Image

While 10% average return it maybe, consecutive 10% return is probably hard to come by. So the years it will take to recoup that 50% loss will be longer, depending on short term market fluctuations (which could add more loss).

But if total loss occurs 1 year after retirement, then the total loss is (200k-36k)/500k or 32.8% loss. If total loss occurs after 2 years, then the total loss is (200k-36k-36k)/500k or 25.6% loss.

So the question is, what's the chance of total loss before the break-even period of 5.555 years?

And the next obvious question is, will you be alive to care? Because after 5.555 years, there is no risk.

JJBean
Posts: 3
Joined: Thu May 01, 2014 4:16 pm

Re: Inflation question...I think

Post by JJBean »

Thank you for the considered reply. That is an interesting twist that I do not have to consider because I have no choice but to take the pension in monthly payments (no lump sum buyout). It was a whole different calculation to decided some years ago whether to stay until retirement eligible - which I decided to do.

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