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Wednesday, April 26, 2017

Future or Today’s Dollars

Posted by Tim Stobbs on December 11, 2007

Perhaps one of the hardest things to wrap you head around when planning your retirement is should you do your math in future dollars or today’s dollars? At first I thought it was just a preference. After all working in future dollars for me has always felt a little wrong. I know that a $1 when I’m 45 won’t buy the same thing as a $1 now. So up to recently I’ve always worked in today’s dollars where I take my rate of return and deduct it by the current inflation rate to ensure when I’m spending $24,000/year in 15 years that it is still buying what I think it should.

Yet there is a problem when you always work in today’s dollars. Your sense of progress might be confused when you look at your numbers again in a few years.  Your today’s dollar calculation is only valid for the day you calculate the number.  After that inflation has altered your spending power.

For example, if you predict your nest egg should go from $75,000 to $100,000 in two years from now in today’s dollars.  You won’t know if you are on track two years later, since inflation has been adding to your numbers.  You might think you are doing when you have saved $107,000, but in reality you should have saved $111,000 to account for inflation.  I know $4000 might not seem like a lot, but magnify that over 15 or 30 years and you can see how big this error can get.

So what is a poor working person to do?  Simple keep your overall math in today’s dollars to make sure your spending power is correct, but when you go to outline your milestones you will want to switch over to future dollars and keep your rate of return at its full value.  That way your road map should let you know if you are on track or not.

I found this to be a very useful exercise since I’ve been thinking I need a nest egg of around $500,000 when I turn 45 in today’s dollars.  Now I realize that number has to be about $250,000 higher when I’m actually turning 45.  Has anyone else had problems with their numbers because it this?  If so, please share your experience.

Comments

8 Responses to “Future or Today’s Dollars”
  1. FourPillars says:

    That certainly is the problem with using today’s dollars.

    The way I sort of get around it is to focus on the age when I can retire. For example if I do the calculation right now I might come up with age 55 for retirement. In five years, I can redo the calculations using updated figures and hopefully the retirement age will still be 55 (or less).

    I hope I explained this properly. It’s not a good solution if you want actual dollar figures for goals but it works for me (at least I think it will).

    Mike

  2. Jordan says:

    Do you still think you will be able to hit your target and retire at 45 now that what you need to save has gone up by 50% (at least in today’s dollars)

  3. Xias says:

    I have definitely run into this problem before as well! Especially considering that inflation is often a hard number to predict. Overall inflation may average out to 2-4% per year, but what about inflation in day to day expenses like energy? Gasoline prices have gone above and beyond anything I could’ve predicted just a few years ago.

  4. I think I am going to use future dollar in my planning, so that it’s easier to know when I arrive there.

    If I want $175,000 in 2014 dollars then when the year 2014 hits I know I will need $175,000 not a number great than that to account for inflation. Inflation may take away from my buying power over time, but a number is a number.

    It’s different when you are working toward a value that you will derive income from. Then it needs to be adjusted to ensure it’s correct as you say.

  5. Canadian Dream says:

    Mike,

    Not a bad idea actually. That way you know you are still on track.

    Jordan,

    I double checked my number and realized I screwed up the increase was only $175,000 more than my original number when you use future dollars. That reality it doesn’t matter. Either case I still have a 1% buffer on my rate of return.

    Xias,

    True. I’m planning using a general inflation number, so when one part spikes it messes things up. Yet if you have some energy holdings it balances off a bit on your return. It’s hard to say if this will be effective in the long term.

    MG,

    Good point. This doesn’t apply to shorter term goals that much.

    Tim

  6. dale says:

    if inflation is x%, your investments (GIC type) would increase by x% in the meantime, no? Am I missing something? I don’t believe basic living expenses will increase by thousands every year.

  7. Canadian Dream says:

    Dale,

    No basic living expenses won’t increase likely by $1000’s per year, but to have the capital to cover those increased expenses might require $1000’s per year.

    So if you experience an extra $400 expenses in a year. Divide that by 0.04 and you would need an extra $10,000 in capital to cover those expenses for the long term. Basically a portion of your investment returns should always be building capital to offset future inflation.

    I hope that helped,
    Tim

  8. Dale says:

    staying with 4s: If you have $400,000 invested at 5% and your living expenses are $20,000 you would still have that $400,000 after spending the $20,000. Taxes and inflation could be covered by whatever pension, CPP, OAS you have. I understand the inflation increase but I wonder how much it would apply once you start living on the investment income. Joe Dominguez in Your Money or Your Life retired about 30 and lived on his investment of about $300,000 in a 5 or 6 percent bond $15,000-$18,000 for the 30 years of the rest of his life. PS New revised, updated version of YMORL just out at library.

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