What is inflation?
Inflation occurs when the demand for goods and services in the market increases at a faster rate than the supply of these items. Thus, inflation is a rise in the general level of prices of goods and services.
How does NewRetirement apply my assumptions for inflation to my plan?
When you enter your optimistic and pessimistic assumptions regarding inflation, the software is applying those rates every year in a linear fashion to any expenses and taxes in the plan.
How does inflation affect my plan in real life?
In real life, increasing inflation has the effect of decreasing our purchasing power. This is because when inflation increases, the prices of goods and services increase and our money buys less. NewRetirement models this decrease in purchasing power by applying your inflation rates to your expenses and taxes, that is - “inflating” them.
What is “account growth rate?”
At NewRetirement, when refer to the growth rate of our asset accounts, we are referring to the annual rate of return. To clarify, we are referring to the “nominal” rate of return. We are not referring to the “real” rate of return which is adjusted for inflation. Because we account for inflation by increasing any expenses and taxes in your plan, it’s not necessary to make an additional adjustment in the asset accounts.
How does the software apply the growth rate to my plan?
A lot of users wonder whether they’re entering the right numbers for account growth and what the norm is. Keep in mind that there is no specific rule you have to follow. This is why we call personal finance personal. You may have an existing investment framework or this might be an area you’re learning more about. Considering your specific accounts, we encourage you to consider the goals you have for each account, as well as the assets you place in each account in order to meet those goals.
Conservative: For example, you may be using a savings account, money market, or bonds to fund a short term goal of saving for a home down payment. You might consider this account Conservative, because it probably holds mostly cash and bonds and you anticipate a low growth rate, between 0 and 3%.
Moderate: You may have children going to college in 7 to 10 years and contribute to a 529 plan with a balance of stock and bonds. You might consider this account balanced, with a moderate growth rate, between 3 and 6%.
Aggressive: You may have an account geared for a goal such as retirement that’s 10 or more years in your future. This account might be more aggressively invested, containing a higher percentage of stock or equities, and anticipating a higher growth rate, between 6 and 10%.
How does the growth rate affect my plan in real life?
In real life, growth rates have a good deal more variability. There may be years or longer periods of higher-than-average growth and years or longer periods of lower-than-average growth. These periods become increasingly relevant as we approach the time we want to withdraw from retirement accounts. This is because we want to make sure that the funds we need are available to fund our retirement plans. For this reason, many individuals reduce their level of risk as they age or employ strategies such as liability matching. We currently offer the ability to effect a one time change to your growth rates to model some of these strategies.
How are inflation and account growth rate related? Doesn’t inflation affect my growth rate?
In real life, as inflation increases the cost of goods and services, it also decreases the value of some assets. This is because inflation and deflation have an inverse effect on certain assets, for example; Treasury bills, Treasury bonds, and TIPs. That is, if inflation increases, bond prices will decrease. And vice versa. If you’re invested in bonds, and the bonds will decrease in value in an inflationary period, the growth rate represents that effect. For this reason, we don’t further adjust the growth rate for inflation. We simply allow you to input a realistic growth rate for each asset account.
Rest assured that the impact of inflation is appropriately addressed in your plan.
You will - independently - enter assumptions for the growth of assets, which may include those which are closely affected by inflation and others that are not. And you will - independently - enter assumptions about inflation which will increase or decrease the expenses and taxes modeled in your plan.
If you would like to review the Planner default assumptions, you may do so here: