[Sticky] Inflation in BodesWell
The term "inflation" refers to the general tendency for prices to go up. "Deflation" is the rare time periods when prices go down. But the basic rule of our current economic society is that prices rise over time. Why? Well, that's a complicated topic that many brilliant people disagree about, so we won't speculate here.
Since prices rise over time, the amount you can buy, your "purchasing power," with a fixed amount of cash, decreases over time. When I was 10, a comic book cost $0.25. Now they cost $2.50 or more.
In personal finance, the rate at which inflation will rise is a crucial assumption for your planning. The lifestyle you can purchase with your retirement nest egg will be more luxurious in a low inflationary period than in a high one, because the purchasing power of your savings will decrease more slowly.
The big problem is, no one knows what the rate of inflation will be in the next quarter or year, let alone decade. Since the late 1980s, inflation has hovered around 3% per year. But in the '70s and '80s, inflation ranged between 5% and 10% for ten years at a time.
So BodesWell deals with inflation by not counting it. In technical terms, all the BodesWell projected numbers are "Real" as opposed to "Nominal". Another way to say this is that we represent projected income, expenses, investments, and debts in today's dollars. If BodesWell projects that your income will be $250,000 in 2030, that's an income projection in today's dollars.
There are several benefits to this approach. The most important one is that it makes your retirement saving goals more comprehensible. When we say that your projected Net Worth at age 65 is $3.4 million dollars, those are in today's dollars.
One implication of using real dollars in our projections instead of nominal dollars is that our asset growth projections will grow more slowly than what you are probably used to. Historically, an index of S&P 500 stocks has grown at 7% per year. But 3% of that growth is attributable to inflation. If you looked at BodesWell projections for an S&P 500 index you'll see it grows closer to 4% because we've removed the effects of inflation.
Since no one knows the future rate of inflation (or the likelihood of deflation) we've removed this variable from BodesWell. This decision makes our projections more relatable. If you have comments or questions about Inflation and BodesWell, please post them below.