Financial Independence Endgame

[sky]

In working out a spreadsheet showing the impact of inflation on expenses over time, I was somewhat surprised by how short of a time that a fixed pension allows a person to maintain an expense level adjusted by inflation. Even when boosted by social security, it is only a matter of years before inflation increases expenses to more than income.

This is quite sobering, and it is making me realize that even though my pension is more than I spend now, and social security is on the way in a few years, by age 70 my ability to maintain a spending lifestyle will be substantially reduced by inflation. By age 85, I will have about half of the spending ability at age 60. Even when counting my investment income, it does not overcome the increased expenditure due to inflation after about 75 years of age.

Assumptions: 4% inflation.

As always, the answer is to reduce expenditures and invest the unspent income. I can also guess my end date at age 100, and start spending my investments down to that date, but it only gives me a few years. I'm sure I could massage the spreadsheet to give a more pleasant outcome. But there is no escape from inflation. At my current expense level, I can maintain until about age 85, then things go downward quickly.

The spreadsheet tells me to keep my expenses low, even when pension/social security increase my annual income to well above my current expense level.

[Ego]

The spreadsheet tells me to keep my expenses low, even when pension/social security increase my annual income to well above my current expense level.

The other side of the equation is also important. The longer one is away from income producing endeavors the more difficult it is to maintain the skills and just plain willingness to work/earn. It is one of the inherent risks of early retirement. Skills/abilities/willingness to earn devalues over time and the longer one is away from "work" the harder it is to find a side gig that helps the retiree keep up with inflation.

The people I know who have been most successful in retirement are those who have a side gig that they think of as a hobby but provides enough income to remove the inflation risk.

[Lemur]

Inflation assumptions are centered around a standard basket of goods...change those basket of goods and inflation becomes more of a non-issue? For example - thinking about owning a home to reduce inflation risk from rising rents. Or reduce inflation risk for food spending category by growing most of your own food. This might be more difficult as one ages so perhaps one could get cheaper food by having stored food for many years - time value of money reduces the costs of the foods therein. Also social security is managed for some inflation risk by COLA adjustments.

[unemployable]

Assumptions: 4% inflation.

As always, the answer is to reduce expenditures and invest the unspent income.

Other solutions include allocating your assets to those with a positive correlation to inflation, and some combination of adjusting your spending away from those goods and services which you believe will inflate the most, and/or front-running expected inflation by buying them when prices are low. Buying a house has already been mentioned; this is the ordinary way the low-Wheaton crowd hedges against inflation, accidentally or intentionally.

Stocks in the long run should be neutral towards inflation. Companies sell goods and get to price them. Eventually they pass along price increases. In regulated and mature industries it may become easier to raise prices more than you really need to. The problem is when inflation in the shorter term is higher than expected and markets believe it will keep rising.

Then you have the sectors which outright benefit from inflation: commodities, consumer staples, REITs and anything real-estate related. Hold those if you're worried. Not sure about TIPS in this environment, but at least you won't lose as much money as you would with Treasuries.

Four percent is well above actual goods and services inflation since the mid-1980s.

Social Security is adjusted by cost-of-living every year, which is not exactly the same as CPI and in fact consistently runs higher than it. Most public pensions are indexed to at least CPI.

[7Wannabe5]

It might not even make sense to look at past numbers since the aging of the population is a known differing factor.

[jacob]

Social Security is adjusted by cost-of-living every year, which is not exactly the same as CPI and in fact consistently runs higher than it. Most public pensions are indexed to at least CPI.

Unless I made a consequential blunder in my SS spreadsheet, SS COLA is based on the National Wage Index. It governs both income indexing and the two break/bend points in the payout calculation. So it's adjusted by the average income of those still working.

You can find the table here: https://www.ssa.gov/OACT/COLA/AWI.html

[Lucky C]

I calculated year-over-year USD inflation stats using Robert Shiller's monthly data going back to 1871 (http://www.econ.yale.edu/~shiller/data.htm):

CPI data + estimated inflation data going back to 1871 (CPI was not published until 1921)
min: -19.6%
max: 23.7%
mean: 2.2%
median: 2.3%
std dev: 5.8%

CPI inflation from ending of the gold standard in August 1971 until present:
min: -2.1%
max: 14.8%
mean: 3.9%
median: 3.0%
std dev: 3.0%

Inflation from 1871 to the ending of the gold standard in August 1971:
min: -19.6%
max: 23.7%
mean: 1.4%
median: 1.3%
std dev: 6.6%

Everyone hates on how ending the gold standard has eroded the value of the US dollar over time, but if you've held more stocks and gold than cash under your mattress it's not a big deal.

The positive side is that the volatility of inflation has gone down dramatically comparing 1971-present to 1871-1971. Since 1971 there have been periods of both high and low inflation/deflation, so running a Monte Carlo simulation (like a DIY Firecalc) using a mean inflation of 3.9% and standard deviation of 3.0% seems reasonable, though realistically it would be skewed toward the higher inflation tail. Mean -2 std dev would be -2.1% deflation which is the absolute lowest we've seen year-over-year since 1971 (only happened due to the GFC), whereas mean +2 std dev would be 9.9% inflation, which seems like a better scenario to prepare for.

Double-digit year-over-year inflation occurred for 15 months in 1974-1975 and 30 months in 1979-1981. In both these instances, it took 40 months for these YoY inflation rates to peak relative to the previous local minimum. So it seems like if another big inflation spike were to occur, it would be unlikely to happen "overnight" and there might be a good opportunity to hedge more against it even if it's already significantly ticked up the past year or two.

[sky]

Thank you for all the helpful comments.

Generally when I put together this type of spreadsheet, either professionally or for personal use, I start with a pessimistic outlook to give a worst case or perhaps negative outlook scenario. I would be most concerned about a revaluation of the USD in the next 40 years, similar to the DM->Euro changeover, or other currency adjustments that have been made that benefit the debtor and punish the saver.

I think that the case that a fixed pension cannot be relied upon for longer periods of time is an important lesson to keep in mind.

However, there is also a lot of good news in my projections. I don't have a problem until fairly late in life, about 25 years out from the present. I have time to respond and fix the issue. Also, my personal income is more complex than shown in the spreadsheet, and generally is better than the spreadsheet scenario, such as COL increases in some pensions, which I did not include in the projection.

What I find most interesting is that if I continue with my 2k current expense level, which is not extremely low or difficult to maintain, and invest the remaining pension and social security income, I could have close to a 50% savings rate. This is just a rough estimate before taxes. I could do ERE all over again, given enough years of life.

I am wondering how others account for end of life in financial projections. I used the age of 100 as a final point, although I don't really expect to reach this age. Do you draw down the investment at any point?

[Sclass]

I’ve had the opportunity to see my mom and my friend’s mom pass over the last couple of years. Two very different outcomes. They both started spending down their savings.

My friend’s mom was 82 and died during a hospitalization. She was living in skilled nursing at the time. My pal said they had $40k left in the account. Enough for two months. He was getting ready to move her into his home and look after her. He told me he was just getting ready to explain the predicament to his wife when his mom died.

My mom was burning at roughly the same rate while living at home while doing home hospice. I had about two years + of money in a stock account left when she passed away. I got a little nervous because she just kept hanging on and costing more but her life force went to zero before her money. Multiple wagers going on there. I inherited the balance but I am so guilty about not blowing it on her while I could. I have not spent a cent of it. It sits in account growing wildly from a stock I bought with it. Kind of a reminder of how winning one side of the bet is worse than winning the other side. I could have spent it on her somehow had I known when she would die.

Guilt aside, my takeaway was stock investment really beat down inflation. Even when the care agency was increasing rates at 20% a year. Have a little faith. Invest well, control expenses and die rich enough to leave something behind.

I spoke to a “wealth manager” about this multiple times. Most clients ($1,000,000 assets and above) plan to have money left at death. Out of thousands of clients he says it cuts both ways. Some end up broke (his method encourages clients to go for broke) and some have money left. The big takeaway is the plans rarely go as planned. A lot happens between 65 and 85. Stupid stuff like divorce, grand kids college, vacation homes and art collections. And serious stuff like runaway care costs. Like my experience those are hard to project because they are a moving target moving faster as the situation drifts towards its inevitable yet uncertain terminus.

I’m not sure money will be the biggest worry at that point. There is a level of care for everyone. The lower the level, the less time you’ll need it. I know, dark. Nothing to fear, rich or poor it all ends the same way in the civilized world. Opiate drip.