Inflation and Financial Planning

Inflation and Financial Planning

The Federal Reserve is dominating headlines with its large interest rate increases as it battles to fend off inflation that has gone from transitory to omnipresent. Mortgage rates are reaching levels not seen in decades. The 30-year fixed is now north of 7%, dampening a once-hot housing market. Inflation! Trips to the grocery store for just a basic level of food to feed a household instill fear as to what the final tab will amount to upon checkout. Inflation!

We have not had to endure this high of an inflation environment since the late 1970s and early 1980s. Is this a short-term phenomenon that we will work our way through? Or will history take us back to the 1970s and inflation that will last for the next decade? How does this impact my retirement planning? Can I retire? Do I need to go back to work? We are fielding these questions with increased frequency.

Financial Planning Inflation – Long-Term

One of the most common questions these days, is what inflation rate we use for projecting costs forward in a retirement plan. We are constantly evaluating our financial planning process in our weekly team meetings to ensure you are getting the best information possible. We use the capital market and inflation assumptions within our MoneyGuidePro financial planning software with only minor changes. We use 2.50% for overall inflation rate, with higher rates of inflation for assisted living/in-home care 4.5%, college education 6.0%, and medical expenses 6.0%.

MoneyGuidePro uses a variety of sources to assemble the long-term capital market estimates, including JP Morgan, BlackRock, T. Rowe Price, Callan, Morningstar, BMO Global, and American Century Investments. The financial planning team of Bedell Frazier scrutinizes these numbers with our investment management team to ensure we are comfortable with the projections we use when creating financial plans.

The big question that comes to mind is whether using the 2.50% inflation rate for long-term financial planning makes sense today, with headline inflation coming in at 3.2%. One way we can monitor market inflation expectations is by looking at Treasury Inflation-Protected Securities (TIPS) breakeven rates for the same maturity in a US Treasury security, which has no inflation protection component. In summary, this gives us a market rate of consensus expectations for future inflation. As of this writing on March 15th 2024, the five-year TIPS/Treasury breakeven is 2.37% and the ten-year is 1.99%, very close to our long-term inflation planning measure of 2.50%. The Market is indicating to us that this inflation we a currently experiencing should be relatively short-lived, definitely hasn’t been transitory, but shouldn’t remain permanent either. Returning to a more modest level of inflation over the next few years makes statistical sense. This would be good news, but still extremely painful to live through in the near term.

Inflation is when you pay fifteen dollars for a ten-dollar haircut you used to get for five dollars when you had hair.

Sam Ewing

Financial Planning Inflation – Other Tools

We have other tools within our software we can use to explore if inflation will impact your retirement plan. In the “What are you afraid of” section of our planning software, we can increase the inflation rate across all your retirement goals to the end of your plan. The program breaks out retirement spending goals into “Needs, Wants, and Wishes.” Needs are your monthly spending and medical goal. The Wants are vacation spending, maybe charitable giving, and money for the grandkids. Wishes would be things like a fancy sports car or a second home for vacations. Everyone’s goals and retirement plan are unique, as well as how they rank their goals into those three buckets.

If inflation ran at 3.5% for your entire retirement plan, instead of the baseline 2.50%, how would this impact your Needs, Wants, and Wishes? When presenting financial plans, people find it illuminating with a sense of relief when they can quantify that their Needs and Wants will be funded even if inflation runs hot for their entire retirement. If there is a less desirable outcome with your planning, we can devise a plan if inflation stays elevated, by pivoting some of your goals.

We can model and explore multiple scenarios so that you feel comfortable with your retirement spending. We can look at the impact on your plan with inflation in mind on a shorter-term basis. We can use a higher inflation rate for your goals for the next five years if you want. We could also look at inflating certain expenses at a higher rate if, for example, you feel travel inflation will stay high for the foreseeable future.

Cash Management

One area where we can assist in planning is cash management/emergency fund. We strongly encourage keeping three to six months of living expenses set aside for unexpected expenses in a rainy-day fund; you can use our Emergency Fund Calculator. The events of the past few years have reinforced the importance of having some money sitting in a safe cash reserve should you need it. With interest rates on the rise, now is not the time to be taking on credit card debt.

Once we have identified the proper amount of cash to be set aside for the emergency fund, we want to make certain that any excess cash reserve is properly invested outside of a regular savings account. Interest rates on savings accounts have not moved much, even as interest rates have increased, letting inflation eat away at its purchasing power. We are seeing attractive rates in the Bond Market for the first time in many years. The US Treasury Market Bonds are especially attractive in this time of tremendous market uncertainty. If your timeline for that use of cash is long-term, if you can find the right entry point, equities may make an excellent hedge against inflation.

“Inflation is the crabgrass in your savings.”

Robert Orben

Personal Inflation Rate

With the constant negative headlines surrounding inflation, it can be stressful for someone to feel comfortable about how their savings will last in retirement. That stress can increase dramatically for those who recently retired or are about to begin drawing on their investment accounts to fund their lifestyle. The Consumer Price Index (CPI) headline inflation number was up an eye-popping 8.3% in the month of September 2022. It has dropped to 3.2% for the February 2024 report. The CPI is a measure the US Bureau of Labor Statistics calculates by combining separate inflation rates on a “basket of goods and services” for Consumers. This is a blanket nationwide number of headline inflation that may or may not reflect how inflation is impacting an individual depending on what region they live in and what they spend their money on.

It can be a useful exercise to go through your budget and see which line items are most affected by the increase in inflation. Everyone spends money differently, so depending on which goods and services you spend the bulk of your budget on and which are non-discretionary, will dictate how much inflation impacts you. From the March 2024 CPI report that covers the change in inflation rates from February 2023 to February 2024, Transportation services was up 9.9%, food was up 2.2%, and shelter 5.7%. But that same report showed that apparel was flat 0.0%, new vehicles 0.4%, and used cars and drops down 1.8%. A very different environment than just two years ago.

The difference between the headline inflation from the CPI and your household inflation rate is an important point to explore. If you are going to change your behavior based on inflation, those changes should be the actual inflation that you are experiencing. A retired couple living in downtown Denver will have a very different personal inflation rate than a couple with four kids in Danville where both parents commute.

The Bedell Frazier Financial Planning Team can account for all these variables in your retirement planning process to give you peace of mind during these volatile market conditions. Now is an excellent time to take the uncertainty out of your retirement by working with us to create your financial plan. If you already have a retirement plan in place, now is a great time to update it. We can also examine different inflation rates to see the impact on your ability to fund your retirement goals if that is something that is keeping you up at night. We are here for you every step of the way!

Now is a great time to revisit your retirement plan. Contact the Bedell Frazier Financial Planning department to assist you with refreshing or designing your detailed financial retirement plan.

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