One of the efforts I had thought about doing for retirement planning was to measure my personal inflation rate in order to have a more accurate value to use than the CPI value. Realistically it’s not going to work – there are too many variables and potential changes in lifestyle. For example over time, our interests may change from cheap hobbies to expensive hobbies, our young son will probably eat more as he gets bigger and will require more money for activities. It will be difficult to separate the basic “retirement spending” from normal spending. The other problem is that there is a fine line between personal inflation rate and plain old overspending. At some point if you are going to retire you have to be able to live within your means even if that entails reducing or eliminating expenditures on activities that you enjoy.
Fabrice Taylor writes in the Globe & Mail about the fact that the CPI doesn’t necessarily match up to the inflation rate that you or I might experience within our lives. This figure is very important for retirement planning since the real rate of return of your investment portfolio is the actual return minus the inflation rate. Taylor refers to a study done in the US which says that the real inflation rate is twice as much as the official rate.
Another good example is financial planning for education costs. I’ve read that post-secondary tuition has gone up about 5% per year over the last decade. If you are doing projections for your education fund then using the CPI will understate the actual inflation since tuition is a big part of the school costs.
Since I’m still a few years away from retirement I don’t worry too much about my assumptions for rate of return and inflation. Personally I use 3% inflation in my calculations which is probably a good enough estimate for my purposes.
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