Know your own inflation rate

NEEDS FIT: THERE IS NOTHING THEORETICAL ABOUT YOUR SPENDING HABITS

Unless individuals understand their personal inflation rate, they may never really create much of a a nest egg for retirement.

Hard as it may be, keeping up with national inflation of 6.5% will do you no good if your personal inflation is 9%. Do the maths.

Many consumers battle to factor into their financial planning our seesawing national inflation rate – tickling 6.8% in December – without ever knowing their personal inflation rate.

Unless individuals and their advisers understand their personal inflation rate, they may never really create much of a nest egg for retirement, says Dave Crawford, retirement skills trainer at Planning Retirement.

Keep it low

“The only solution seems to be for people to keep their personal inflation rate as low as possible to allow their investments to prosper.”

If your personal inflation rate is 9% and you invest in a portfolio targeting a return of CPI plus 3% in an environment where inflation is 6.8%, the return generated by the portfolio (an assumed 9.8%) doesn’t really help you to create wealth, Crawford says.

“And remember these returns need to be after costs have been deducted.”

But how?

As a starting point, you need to calculate your standard of living. In short, your living standard is what is left of your total monthly earnings (salary, bonus, allowances and other taxable income) after all the amounts that you don’t or can’t spend (taxes, contributions to savings and mortgage payments) are deducted.

Calculating your standard of living is also an important starting point in determining whether you are on track to retire comfortably.

Calculating your standard of living each year as part of the financial planning review process can also provide valuable insight into your personal inflation rate.

If the process is repeated each year, it could also be used to calculate your average inflation over time, which could be helpful if you need to adjust your living standard downward over time.

The difference between your living standard in 2017 and 2016 (the percentage increase in spending) is effectively your personal inflation rate, Crawford explains.

“This creates an interesting situation. If one’s investments only grow (after costs) by the [personal] inflation rate then they are merely maintaining their buying power. The rate at which they grow above [personal] inflation is the real generator of wealth.”

Once people know how to measure their personal inflation rates they are in a position to make changes.

Without measurement, they are just guessing, he says.

“Getting your personal inflation down is a major part of improving retirement preparation. Keeping investment costs down is significant,” says Crawford.